Comparative+Advantage+Example

 //Week 1: The Gains from Trade//
Tess has 40 hours a week with which she can color or make mudpies. It takes 1 hour to color a picture, and 3 hours to produce a mudpie.

1. Graph Tess' production possibility frontier (PPF), with the quantity of pictures on the vertical axis.

[|Tess' PPF]

Explanation: The vertical intercept is the maximum number of pictures Tess can produce. She has 40 hours and it takes 1 hour to produce each pictures, therefore she can produce at most 40 pictures. The horizontal intercept is the maximum amount of mudpies she can produce. Since it takes 3 hours to produce each mudpie, she could produce 40 / 3 = 40/3 (or 13 1/3 mudpies).

Note that this graph was done in lucid chart. To produce a chart in lucid chart (once you have created your account), hit the New document link on the right hand side of the page, then choose a blank document. Almost all of the graphs we do in this class can be done using the line tools, which run along the top of the page. Once you choose which line options you want (i.e. the thickness of the line), you can right click to choose to draw a line. Graphs can be labeled by dragging the text tools (T) from the left hand side of the page to your graph.

Once you have completed your graph, you can create a link to the graph by hitting the share button on the top of the page. Under the publish tab, it give you a number of options. I created this graph by choosing the Web page option, and selecting the image.

There are other was to create your graphs as well. For example, Microsoft's powerpoint has line drawing tools as well, and you could save the resulting graph as a pdf or picture and upload it to your wikipage. If you have questions about any particular tool, feel free to ask me.

2. What is the opportunity cost of producing a mudpie (in terms of pictures) for Tess?

Tess' opportunity cost of producing a mudpie is 3.

Explanation: The opportunity cost of producing a mudpie is how many pictures she has to give up to produce a single mudpie (or the change in the number of pictures / the change in the number of mudpies). It is also the slope of the PPF. In This case, the slope of Tess' PPF is -40/(40/3) = -3. See the graph above.

3. Now assume that Tess' sister Becca can also color and produce mudpies with her 40 hours of labor. However, Becca takes 2 hours to color a picture and 0.5 hours to make a mudpie. Graph Becca's PPF. What is the opportunity cost of producing mudpies for Becca?

Becca's PPF

Becca's opportunity cost of producing mudpies is 1/4 pictures. See explanation above.

4. Which sister has the absolute advantage in producing mudpies? Which sister has the absolute advantage in producing pictures? Explain your answer.

Tess has the absolute advantage in producing pictures; she takes fewer hours to produce each picture than Becca. Becca has an absolute advantage in mudpies for a similar reason.

5. Should these sisters trade? Why or why not? If they should trade, which product should Becca specialize in, and why?

The sisters should trade. Tess has a comparative advantage in producing pictures because she has a lower opportunity cost of producing pictures. Likewise, Becca has a comparative advantage in producing mudpies as she has a lower opportunity cost of mudpies. By each specializing in what they have a comparative advantage in, both sisters will be able to consume more of both goods. For example, lets say they each specialize (Tess in pictures and Becca in mudpies), and Becca trades each mudpie to Tess for a single pictures. The following graph shows Becca's new consumption possibilities, which exceed her original consumption possibilities before she traded with Tess.

[|Becca's Consumption Possibilities]