Question

Suppose that, working full time, peter can produce either 100sweaters or 40 suits per year, whereas Jane can produce 400 sweaters or 48 suits.

Define and calculate absolute advantage.                                          

Define and calculate comparative advantage?                                   

If they fully specialized in a good of comparative advantage what price will they exchange suits for sweaters?                                                                     

If peter fully specialized and Jane specialized 25percent on suits and 75 percent on sweaters. What price will they exchange suits for sweaters

Answer 1

Absolute advantage means advantage because of higher efficiency which results in higher production of a particular commodity vis-a-vis other commodity/ies. In the given scenario, Peter has absolute advantage in producing sweaters (100 sweaters > 40 suits) and Jane has absolute advantage in producing sweaters (400 sweaters > 48 suits).

Comparative advantage means advantage due to lower relative opportunity costs. In the given scenario, respective opportunity costs are matrixed below:

	PETER	JANE
	Units	Op. Cost	Op. Cost per unit	Units	Op. Cost	Op. Cost per unit
SWEATER	100	40	0.4	400	48	0.12
SUITS	40	100	2.5	48	400	8.33

As apparent from the above matrix, for Peter, opportunty costs for suits is lower (2.5 sweaters ) than that of Jane (8.33 sweaters). Therefore Peter has comparative advantage in producing suits. Jane's opportunty costs for sweaters is lower (0.12 suits ) than that of Peter (0.40 suits). Therefore Jane has comparative advantage in producing sweaters.

Exchange rate range:

Peter will trade 40 suits for 100 sweaters and Jane will trade 400 sweaters for 48 suits (or 100 sweaters for 12 suits). The exchange rate range is 40 suits / 100 sweaters to 12 suits / 100 sweaters

or 100 / 40 to 100 / 12

or 2.5 sweaters to 8.33 sweaters for a suit (acceptable to Peter and to Jane respectively)

With the given efficiency levels for Jane, comparative advantage for Sweaters would remain but the opportunity costs for producing 533 sweaters (re-instating 75% efficiency output of 400 @100% efficiency) oportunity costs becomes 192 suits (re-instating 25% efficiency output of 48 @100% efficiency) making their acceptable exchange rate 2.77 sweaters for a suit.