Question

Eleanor and Kyoko are roommates. They spend most of their time studying (of course), but they leave some time for their favorite activities: making pizza and brewing root beer. Eleanor takes 4 hours to brew a gallon of root beer and 2 hours to make a pizza. Kyoko takes 6 hours to brew a gallon of root beer and 4 hours to make a pizza.

Eleanor's opportunity cost of making a pizza is of root beer, and Kyoko's opportunity cost of making a pizza is of root beer.

has an absolute advantage in making pizza, and has a comparative advantage in making pizza.

If Eleanor and Kyoko trade foods with each other, will trade away pizza in exchange for root beer.

The price of pizza can be expressed in terms of gallons of root beer. The highest price at which pizza can be traded that would make both roommates better off is of root beer, and the lowest price that makes both roommates better off is of root beer per pizza.

Answer 1

Opportunity cost is the cost of foregoing the next best alternative use of the input of production. In this case, person E can make 1 pizza in 2 hours, that is can make 1/2 pizza in 1 hour. Similarly, she can make 1/4 gallons of root beer in one hour. Then her opportunity cost of producing 1/2 pizza is equal to 1/4 gallons of root beer. Or, the opportunity cost of making 1 pizza is 1/2 gallons of root beer.

For person K, the opportunity cost of producing 1/4 pizzas is 1/6 gallons of root beer. The opportunity cost of producing 1 pizza is 1/61/4=2/3 gallons of root beer.

The absolute advantage occurs when a person can make more of one good with all its resources. In 24 hours person E can make 24/4=6 gallons of root beer and 12 pizzas. While person K can produce 24/6=4 gallons of root beer and 6 pizzas. Then E has an absolute advantage in producing both root beer and pizza.

The comparative advantage occurs when a person has a lower opportunity cost of producing a good. The opportunity cost table is given below

	Pizza	Beer
E	1/2	2
K	2/3	1.5

The person E has a comparative advantage in producing pizza, while K has it in Beer.

After the trade, the person with comparative advantage produces and trades the respective item. Then E makes pizzas and trades them for beer. As K buys pizza the highest price for which she will interest in buying the pizza is her opportunity cost of production for pizza, which is 2/3 gallons of beer. The highest price for the trade of pizza is thus 2/3 gallons of beer. Similarly, the lowest price must be the opportunity cost of the seller. This is 1/2 gallons of root beer for a pizza.