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Suppose that two people, Michelle and James each live alone in an isolated region. They each have the same resources available, and they grow potatoes and raise chickens. If Michelle devotes all her resources to growing potatoes, she can raise 200 pounds of potatoes per year. If she devotes all her resources to raising chickens, she can raise 50 chickens per year. (If she apportions some resources to each, then she can produce any linear combination of chickens and potatoes that lies between those extreme points. If James devotes all his resources to growing potatoes, he can raise 80 pounds of potatoes per year. If he devotes all his resources to raising chickens, he can raise 40 chickens per year. (If he apportions some resources to each, then he can produce any linear combination of chickens and potatoes that lies between those extreme points.)

Potatoes Chickens
Michelle 200 50
James 80 40

-What is Michelle's opportunity cost of producing potatoes?
-What is Michelle's opportunity cost of producing chickens?
-What is James' opportunity cost of producing potatoes?
-What is James' opportunity cost of producing chickens?
-Which person has an absolute advantage in which activities?
-Which person has a comparative?
-Suppose that they are thinking of each specializing completely in the area in which they have a comparative advantage, and then trading at a rate of 2.5 pounds of potatoes for 1 chicken, would they each be better off? Explain.
-How would you extend the above narrative to businesses, society as a whole or nations? Explain.

#### Solution Preview

-What is Michelle's opportunity cost of producing potatoes?
Opportunity cost refers to the value of the sacrificed alternative.
So, Michelle's opportunity cost of producing 200 pounds potatoes=50 chickens
Michelle's opportunity cost of producing 1 pound potatoes=50/200=0.25 chickens

-What is Michelle's opportunity cost of producing chickens?
Michelle's opportunity cost of producing 50 chickens=200 pounds potatoes
Michelle's opportunity cost of producing 1 chicken=200/50=4 pounds potatoes

-What is James' opportunity cost of producing potatoes?
James' opportunity cost of producing 80 pounds potatoes=40 chickens
James' opportunity cost of producing 1 pound potatoes=40/80=0.50 chickens

-What is James' opportunity cost of producing chickens?
James' opportunity cost of producing 40 chickens=80 pounds potatoes
James' opportunity cost of producing 1 chicken=80/40=2 pounds potatoes

-Which person has an absolute advantage in which activities?
We find that if Michelle applies all of his resources in potato production, he output is 200 pounds. If James applies all of his resources in potato production, his output is 80 pounds. Clearly, Michelle can produce more. He has an absolute advantage in producing potatoes.
We find that if ...

#### Solution Summary

Solution provides answers for the given questions based upon absolute and comparative advantage concepts.

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