Consider two people, Diane and Rory, each producing both beer (B) measured in qu
ID: 1220171 • Letter: C
Question
Consider two people, Diane and Rory, each producing both beer (B) measured in quarts, and Pizza (P) measured in units. Assume it takes Diane 10 hours to produce 1 pizza; whereas it takes Rory 8 hours to produce 1 quart of bear and 8 hours to produce 1 pizza. Define absolute advantage, comparative advantage, and opportunity cost. Use full sentences. Which person possesses the absolute advantage in the production of each good? Why? Using the information given, calculate the opportunity cost of producing each good for each person. Explain your answer. Which person possesses the comparative advantage in the production of each good? Why? If Diane and Rory decide to trade, who will produce extra beer to trade, and who will produce extra pizza to trade. Why?Explanation / Answer
a) Absolute advantage is the ability of a country or an organization to produce goods or render services at lower cost than others. It means it needs less resources.
Comparative advantage is the ability of a country or an organization to produce goods or render services at lower opportunity cost. It means it has lower marginal cost than other.
Opportunity cost is the benefits foregone over economic choice made for any other option for achieving something.
b) Rory takes 8 hours each for pizza and beer which lower than Diane who needs 10 hours for beer and 12 hours for pizza. This Rory has absolute advantage in this case.
c) For Rory
Opportunity cost of making 1 quart beer = 1 pizza
Opportunity cost of making 1 pizza = 1 beer
For Diane
Opportunity cost of making 1 quart beer = 0.83 pizza
Opportunity cost of making 1 pizza = 1.2 quart beer
d) Diane has lower opportunity cost in producing 1 quart beer so she has comparative advantage in producing beer. While Rory has same opportunity cost for making pizza and beer, she has comparative advantage in making pizza compared to DIane.
e) As Diane has lower opportunity cost in making beer and thus comparative advantage, she will produce extra beer while Rory will make extra pizzas for trade.