Question

Opportunity cost for Mary for 1 tray of biscuits = 1 pound of tea

Opportunity cost for Zoe for 1 tray of biscuits = 3/2=1.5 pounds of tea

Opportunity cost for Bill for 1 tray of biscuits = 1/3 = 0.33 pounds of tea

If someone wanted to trade with them at the rate of 2 trays of biscuits for 1 pound of tea and is happy to buy or sell each of the goods, should Mary, Zoe or Bill accept a deal? If so, how much of each good should they produce to maximize their consumption possibilities? Who should produce what? How would this look on a graph?

Answer 1

For Each pound of tea, they spend:

M = 1 tray of biscuits

Z = 2/3 tray of biscuits

B = 3 trays of biscuits

So, Bill is better off by trading with the person. HE only has to spend 2 trays instead of 3 to get same amount of tea.

Similarly, For a pair of trays of biscuits, They spend:

M =  2 lbs of tea

Z = 3 lbs of tea

B = 2/3 lbs of tea

So, Mary and Zoe will trade off as for same amount of biscuits, they will spend much lesser.

By above analysis, We can see that Bill has comparitive advantage in the production of biscuits as it has lower opportunity cost. It can leverage this position and should produce biscuits.

Mary and Zoe should produce tea as they have comparitive advantage in production of tea.

Mary should produce 1/2 of tea for trade to get maximum consumption

Zoe should produce 2/3 for trade for maximum consumption

Bill should produce 1/3 of biscuits for trade for max consumption.