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Opportunity Cost

1. Country X's production possibilities frontier is given by the following table:

Combination Health Care All Other Goods
A 0 200
B 50 180
C 100 140
D 150 80
E 200 0

And Country Y's production possibilities curve is given by:

Combination Health Care All Other Goods

A 0 100
B 40 90
C 80 72
D 120 40
E 160 0

Further assume that each country is currently producing and consuming at Point C on its production possibilities frontier.

a. Calculate the opportunity cost for providing health care in terms of how much of "all other goods" needs to be given up for each of combinations given above for both Country X and Country Y.

b. Given the current production and consumption levels for each country, which country has a comparative advantage in providing health care? Which has a comparative advantage in producing all other goods?

c. If trade takes place, what is the direction of trade? Which country exports health care and imports all other goods? Is there a limit to how much specialization takes place?

Solution Preview

Before getting into the actual solution it will be a good idea to list out certain terms. The opportunity cost is the cost of the next best alternative. It is mathematically defined as

Opportunity Cost = What you Lose / What you Gain

The other thing to note is that if you find the opportunity cost of S in terms of T is P, then the opportunity cost of T in terms of S will always be 1/P.

a. To find the opportunity cost we just need to go from one combination to other and apply the formula above. For health care the opportunity cost in Country X are,

A to B -> What you lose / What you gain = 20/50 ...

Solution Summary

Opportunity Cost is discussed.