Question

Assume that Maya and Miguel can switch between producing mixers and producing toasters at a constant rate.

Amount produced per week                                                                                                                                                   

Mixers                 Toasters                                                                                                           

Maya                                          5                             8                                                                                                                            

Miguel 2                             4

(a) What is the opportunity cost of one mixer for Maya? For Miguel?

(b) Who has the comparative advantage in producing mixers?

(c) Who has the comparative advantage in producing toasters?

(d) If the terms of trade are 1 mixer exchanges for 1.8 toasters, will trade take place between Maya and Miguel? Why or why not?

Answer 1

(a) The opportunity cost of one mixer

For Maya = 8/5 = 1.6 Toaster ( Making 1 mixer costs Maya 1.6 toaster)

For Miguel = 4/2 = 2 Toaster

(b) Maya has a lower opportunity cost so she has a comparative advantage in making Mixers

(c) Opportunity cost for one Toaster

For Maya = 5/8 = 0.6 Mixer

For Miguel = 2/4 = 0.5 Mixer

So Miguel has a comparative advantage in Toaster.

(d) The trade will take place. Take a look at this table

	Mixers	Toaster
Maya	1.6 Toasters	0.6 Mixers
Miguel	2.0 Toasters	0.5 Mixers

The opportunity cost for Maya to make mixer is 1.6 toasters and, for Miguel, is 2 toasters. Maya is sacrificing 1.6 toasters for I mixer but with trade she will get 1.8 toaster so she is benefitting. For Miguel, the Mixer would have costed him 2 toasters but with trade he can buy for 1.8 toaster so it is a win win for both parties and hence the trade will take place. Maya will sell the mixer and Miguel will buy it.