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**Unformatted text preview: **Chapter 2 Comparative advantage: the basis for exchange 20 May 2011 1. 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? Answer: While not necessary, it is often useful to summarize the provided information in a matrix. Waxing Washing Ted 4/day 12/day Tom 3/day 6/day Both Ted and Tom have two options to choose from: waxing cars or washing cars. If they choose to wax cars, they will forgo washing cars, vice versa. From the information, we can see that Ted has absolute advantage in waxing cars over Tom because given the same amount of resources/time, Ted can wax more cars than Tom. Similarly, Ted also has absolute advantage in washing cars over Tom because given the same amount of resources/time, Ted can wash more cars than Tom. The concept of comparative advantage is related to opportunity cost. Opportunity cost is the value of your next best alternative that you must forgo in order to engage in your current activities. We can calculate opportunity cost using the following formula: • Opportunity cost of current activity = Unitof forgoneactivity youcandoinagivenamountof time Unitof currentactivity youcandoinasamegivenamountof time Applying the above formula, we can also compute • Ted's opportunity cost of waxing a car is 12 4 = 3 units of car washed. • Ted's opportunity cost of washing a car is 4 12 = 1 3 units of car waxed. Similarly, we can apply the same formula to compute • Tom's opportunity cost of waxing a car is 6 3 = 2 units of car washed. • Tom's opportunity cost of washing a car is 3 6 = 1 2 units of car waxed. Comparative advantage refers to one's relative e ciency in doing an activity over the other person. In other words, if person A has a comparative advantage in an activity over another person B, A must have a lower opportunity cost of doing the activity than B. Who has a comparative advantage in washing cars? Since Ted has a lower opportunity cost of washing cars ( 1 3 units of car waxed) than Tom ( 1 2 units of car waxed), Ted has a comparative advantage in washing cars over Tom. Same logic can be applied to comparative advantage in waxing cars. Since Tom has a lower opportunity cost of waxing cars ( 2 units of car washed) than Ted (3 units of car washed), Tom has a comparative advantage in waxing cars. More generally, in a two-person, two-task case, if A has a comparative advantage in performing one task over person B then B must have a comparative advantage in performing the other task over A. 1 2. 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?...

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