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econ1001_endofchapter02

# econ1001_endofchapter02 - Chapter 2 Comparative advantage...

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Chapter 2 Comparative advantage: the basis for exchange

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Problem #1, Chapter 2 Ted can wax 4 cars per day or wash 12 cars. Tom can wax 3 cars per day or wash 6. What is each man’s opportunity cost of washing a car? Who has comparative advantage in washing cars?
Solution to problem #1 (1) Both Ted and Tom have two options to choose from: waxing cars or washing cars If one chooses to wax (wash) cars, one will have to forgo washing (waxing) cars Opportunity Cost The value of your next best alternative that you must forgo in order to engage in your current activities

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Solution to problem #1 (2) Ted If Ted chooses to wash a car, he will have to forgo having 1/3 car waxed The 1/3 car wax forgone is actually his opportunity cost of having a car wash Opportunity cost = relative efficiency of two activities Units of forgone activity you can do in a given amount of time/ Units of current activity you can do in a same given amount of time Waxing Washing Ted 4/hr 12/hr Tom 3/hr 6/hr
Solution to problem #1 (3) Applying the above formula, we can also compute Ted’s opportunity cost of waxing a car 12 units of car wash forgone in an hour / 4 units of car wax can be performed in an hour Ted’s opportunity cost of waxing a car is 3 units of car wash Tom Similarly, Tom’s opportunity cost of washing a car is 3 units of car wax forgone in an hour/ 6 units of car wash can be performed in an hour Tom’s opportunity cost of washing a car is 0.5 unit of car wax

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Solution to problem #1 (4) We can also compute Tom’s opportunity cost of waxing a car using the formula discussed 6 units of car wash forgone in an hour / 3 units of car wax can be done in an hour Tom’s opportunity cost of waxing a car is 2 units of car wash Who has a comparative advantage in washing cars?
Solution to problem #1 (5) Comparative advantage Notion of comparative advantage refers to one’s relative efficiency in doing an activity over that of the other person In other words, if one has a comparative advantage in an activity over another person’s, one will have a lower opportunity cost of doing the activity than the other person Since Ted has a lower opportunity cost of washing cars (1/3 units of car wax forgone) than Tom whose opportunity cost of washing cars is 1/2 units of car wax forgone), TED HAS A COMPARATIVE ADVANTAGE IN WASHING A CAR Same logic can be applied to comparative advantage in waxing cars

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Ted can wax a car in 20 minutes or wash a car in 60 minutes. Tom can wax a car in 15 minutes or wash a car in 30 minutes. What is each man’s opportunity cost of washing a car? Who has comparative advantage in washing cars? Chapter 2, Problem 2
Wax car Wash car Ted 20 minutes 60 minutes Tom 15 minutes 30 minutes Note: the information given is in “minutes” Ted opportunity cost of washing a car: 60 minutes/20 minutes = 3 waxing job Tom opportunity cost of washing a car: 30 minutes/15 minutes = 2 waxing job Since Tom has a lower opportunity cost of washing a car than Ted does, Tom has a comparative advantage in washing cars.

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econ1001_endofchapter02 - Chapter 2 Comparative advantage...

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