Opportunity Cost and Comparative Advantage

There is another way to look at the cost of producing potatoes. Rather than comparing inputs required, we can compare the opportunity costs. Recall from Chapter 1 that the opportunity cost of some item is what we give up to get that item. In our example, we assumed that the farmer and the rancher each spend 8 hours a day working. Time spent producing potatoes, therefore, takes away from time available for producing meat. When reallocating time between the two goods, the rancher and farmer give up units of one good to produce units of the other, thereby moving along the production possibilities frontier. The opportunity cost measures the trade-off between the two goods that each producer faces.

Let's first consider the rancher's opportunity cost. According to the table in panel (a) of Figure 1, producing 1 ounce of potatoes takes 10 minutes of work. When the rancher spends those 10 minutes producing potatoes, she spend» 10 minutes less producing meat. Because the rancher needs 20 minutes to produce 1 ounce of meat, 10 minutes of work would yield Vi ounce of meat. Hence, the rancher's opportunity cost of producing 1 ounce of potatoes is ounce of meal.

Now consider the farmer's opportunity cost. Producing 1 Ounce of potatoes takes him 15 minutes. Because he needs 60 minutes to produce 1 ounce of meat, 15 minutes of work would yield '/< ounce of meat. Hence, the farmer's opportunity cost of 1 ounce of potatoes is '/« ounce of meat.

Table I shows the opportunity costs of meat and potatoes for the two producers. Notice that the opportunity cost of meat is the inverse of the opportunity cost of potatoes. Because 1 ounce of potatoes costs the rancher ounce of meat, 1 ounce of meat costs the rancher 2 ounces of potatoes. Similarly, because 1 ounce of potatoes costs the farmer '/»ounce of meat, 1 ounce of meat costs the farmer 4 ounces of potatoes.

Economists use the term comparative advantage when describing the opportunity cost of two pnxJucvrs. The producer who givers up less of other goods to produce Cocxl X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it, In our example, the farmer has a lower opportunity cost of producing potatoes than the rancher: An ounce of potatcx-s costs the farmer only '/«ounce of meat, but it costs the rancher Vi ounce of meat. Conversely, the rancher has a lower opportunity cost of producing meat than the farmer: An ounce of meat costs the rancher 2 ounces of potatoes, but it costs the farmer 4 ounces of potatoes. Thus, the farmer has a comparative advantage in growing potatoes, and the rancher has a comparative advantage in producing meat.

Although it is possible for one person to have an absolute advantage in both goods (as the rancher dix-s in our example), it is impossible for one person to have a comparative advantage in both goods. Because the opportunity cost of one good is the inverse of the opportunity cost of the other, if a person's opportunity cost of one good is relatively high, the opportunity cost of the other good must be relatively low. Comparative advantage reflects the relative opportunity cost. Unless two people have exactly the sime opportunity cost, one person will have a comparative advantage in one good, and the other person will have a comparative advantage in the other good.

comparative advantage the ability to produce a good at a lower oppor turuty coit than another producer

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