Chapter 3 Notes
• Suppose there are 2 people trapped on an island: Robert the potato farmer and Aaron the beef rancher.
• Only two goods are produced: potatoes and meat, and each person can produce both goods.
• The following table gives information on how much they can produce of each good:
• MEAT or POTATOES
• Robert 8 oz 32 oz
• Aaron 24 oz 48 oz
Suppose Robert and Aaron fend for themselves:
• Each consumes what they each produce.
• So, the production possibilities frontier is also a consumption possibilities frontier.
• Let’s compute the opportunity costs of producing each good for each person: (let’s ignore the units of
measurement for now).
• To get 32 potatoes, give up 8 meat
To get 1 potato, give up ¼ meat
The opp.cost of a potato = ¼ meat
The opp.cost of a meat = 4 potatoes
• To get 48 potatoes, give up 24 meat
To get 1 potato, give up ½ meat
The opp.cost of a potato = ½ meat
The opp.cost of a meat = 2 potatoes.
• Let’s compare their opportunity costs:
Opp.Cost of Opp.Cost of
a Potato a Meat
Robert ¼ meat *lower o.c 4 potatoes
Aaron ½ meat 2 potatoes ** lower
Robert has a lower opportunity cost of producing potatoes (1/4 meat compared to 1/2 meat forAaron).
• We say Robert has a comparative advantage in potatoes: he can produce them at a lower opportunity
cost than someone else.
• Aaron has a lower opportunity cost of producing meat (2 potatoes compared to 4 potatoes: Aaron has a
comparative advantage in meat.
Robert should specialize in the production of potatoes and trade potatoes for meat.
Aaron should specialize in producing meat and trade meat for potatoes.
When they trade with each other, they can consume more of both goods!
Suppose that when they fend for themselves:
• Aaron produces and consumes 24 potatoes and 12 meat.
• Robert produces and consumes 16 potatoes and 4 meat.
In summary, when there exists a comparative advantage, each individual should specialize in the production of
the good in which they have comparative advantage. They should trade with each other. There will be gains from trade for both.
• Aaron has an absolute advantage in the production of both meat and potatoes.
• Absolute Advantage: the producer who requires a smaller quantity of inputs (fewer resources) to
produce a good (ie is more productive) has an absolute advantage in producing that good)
WHY? Aaron only needs 10 min to produce a potatoe and 20 for a meat compared to Robert who needs 15 and