Question

Steve and Bill both produce computers and smart watches. If Steve uses all his resources on computers he can make 3 million computers per year. If he use all their resources on watches, Steve can make 5 million watches a year. If Bill uses all his resources they can make 2 million computers a year and if he use all of his resources on watches he can make 7 million watches per year. This information is summarized in the following table.

Table 2: Amount of each good each individual could produce if he only produced that particular good

   Computers Watches

Steve 3 million 5 million

Bill 2 million 7 million

a. Who has an absolute advantage in computers? In watches?

b.Find the opportunity cost of each good for each company. Fill in the table below with the opportunity costs (make sure you use the correct units).

Table 3: Opportunity Costs

Computers Watches

Steve

Bill

c. Who has comparative advantage in computers? In watches?

d. If Steve and Bill were to trade products with each other, who will trade away watches in exchange for computers?

e. The price of watches can be expresses in terms of computers. What is the highest price at which watches can be traded that would make both agents better of? What is the lowest price? Explain.

Answer 1

	Computer	Watches
Steve	3 Million	5 Million
Bill	2 Million	7 Million

a.

A Producer has absolute advantage in a good when it can produce higher quantity as compared to its competitor.

Steve can produce 3 million computers while Bill can produce 2 million computer. Steve can produce more as compare to Bill. So Steve has an absolute advantage in production of Computers.

Steve can produce 5 million watches while Bill can produce 7 million watches. Bill can produce more as compare to Steve. So Bill has an absolute advantage in production of watches.

b.

Opportunity cost:

Steve's opportunity cost of producing 1 unit of computer= 5/3 or 1.66 watches

Steve's opportunity cost of producing 1 unit of watches= 3/5 or 0.6 computer

Bill's opportunity cost of producing 1 unit of computer= 7/2 or 3.5 watches

Bill's opportunity cost of producing 1 unit of watches= 2/7 or 0.28 computer

c.

A Producer has Comparative advantage in production of a good when it can produce a good at lower opportunity cost as compared to its competitor.

Steve has comparative advantage in production of computers.

Bill has comparative advantage in production of watches.

d.

As Bill has comparative advantage in production of watches. So Bill will produce watches and trade away watches in exchange for computers.