Table of Contents
Introduction
Opportunity cost is the real cost of output forgone as a result of choosing to invest in an alternative option from severally mutually exclusive choices that are available for investment. It can also be use to mean the benefits lost as a result of investing in a different alternative but equally beneficial opportunity that is available among many options (Mankiw, 2008).
Opportunity cost
The opportunity cost of Michelle producing potatoes is 0.25. This means that for every one pound of potatoes he she choose to produce he has to forgo for 0.25 of chicken. Michelle’s opportunity cost of producing chickens is 4 (Mankiw, 2008).This means that for every one chicken that Michelle produces she has to forgo an opportunity cost of 4 pounds of potatoes. On the other hand James’ opportunity cost of producing potatoes is 0.5. This means that for every one pound of potatoes he chooses to produce, he has to forgo an opportunity cost of 0.5 of chicken. On the contrary the opportunity cost of producing chicken for James is 2. This means therefore that for every one chicken he chooses to produce, he has to forgo an opportunity cost of 2 pounds of potatoes (Lawrence, 2008).
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Absolute advantage is the ability of someone to produce more of a service or a good than his or her competitors given the same amount of resources and opportunity. Michelle has absolute advantage in producing both potatoes and chickens. This is so because given the same amount of resources like James, She can produce more of potatoes and chickens compared to James. That is she can produce 200 pounds of and 50 chickens unlike James who manages to produce only 80 pounds of potatoes and 40 chickens in the same piece of land (Lawrence, 2008).
Comparative advantage on other hand is means the ability of an individual or a firm to produce a certain good or service at a lower opportunity cost than other individuals or firms. It can also be use to mean the ability to produce a certain product with the highest relative efficiency compared to the production of the alternative products. In this case, Michelle has a comparative advantage in the production of potatoes compared to the James. This is because he can produce potatoes at an opportunity cost of 0.25 unlike James who produces at an opportunity cost of 0.5.On the contrary; James has a comparative advantage over Michelle in the production of chickens. This is so because he can manage to produce chicken at an opportunity cost of only 2 while Michelle has to forgo an opportunity cost of 4 in order to produce chickens (Lawrence, 2008).
If they both decide to produce what they have comparative advantage, they will be better of as their total production will increase. After trade off Michelle who was initially producing 200 pounds of potatoes and 50 chickens will now produce 800 pounds of potatoes and 0 chickens while James will produce 80 chickens up from 40.the end result is that the amount of potatoes will increase from 280 pounds to 880 pounds while the number chicken also increased from 90 to 140, so both benefited from the trade off (Michael, 2008).
From practicing trade off and the concept of comparative advantage, firms, individuals or nations involved can greatly benefit from the trading and create value for both groups even if one nation can create all goods using limited resources compared with other nations. These net benefits of such an outcome are referred to as gains from trade. This is where the theory of international trade is derived from (Robert, 2008). For example, a country like Portugal whereby it is easy to produce corn can decide to produce it in excess and trade that wine or clothes which can easily and cheaply produce them. The two countries will mutually benefit as they can get these cheaply. The conclusion is that each country can gain by specializing in the production of good that they have comparative advantage, and trading the good for other (Michael, 2008).