Pat and Kris are roommates. They spend most of their time...

Pat and Kris are roommates. They spend most of their time studying (of course), but they leave some time for their favorite activities: making pizza and brewing root beer. Pat takes 4 hours to brew a gallon of root beer and 2 hours to make a pizza. Kris takes 6 hours to brew a gallon of root beer and 4 hours to make a pizza. a. What is each roommate's opportunity cost of making a pizza? Who has the absolute advantage in making pizza? Who has the comparative advantage in making pizza? b. If Pat and Kris trade foods with each other, who will trade away pizza in exchange for root beer? c. The price of pizza can be expressed in terms of gallons of root beer. What is the highest price at which pizza can be traded that would make both roommates better off? What is the lowest price? Explain.

Pat and Kris are roommates. They spend most of their time studying (of course), but they leave some time for their favorite activities: making pizza and brewing root beer. Pat takes 4 hours to brew a gallon of root beer and 2 hours to make a pizza. Kris takes 6 hours to brew a gallon of root beer and 4 hours to make a pizza.
a. What is each roommate's opportunity cost of making a pizza? Who has the absolute advantage
in making pizza? Who has the comparative advantage in making pizza?
b. If Pat and Kris trade foods with each other, who will trade away pizza in exchange for root beer?
c. The price of pizza can be expressed in terms of gallons of root beer. What is the highest price at which pizza can be traded that would make both roommates better off? What is the lowest price? Explain.

Key Concepts

Comparative Advantage

Comparative advantage is the ability of an entity to produce a good at a lower opportunity cost compared to others, even if one party has an absolute advantage in all goods. This principle is fundamental in trade theory and helps explain how and why entities benefit from specializing in the production of goods in which they have a relative efficiency advantage and then trading with others.

Opportunity Cost

Opportunity cost represents the value of the next best alternative that must be sacrificed when a decision is made. In the context of production and trade, it measures how many units of another good could have been produced if resources were allocated differently. This concept is essential for understanding trade-offs between different activities or production choices.

Absolute Advantage

Absolute advantage refers to the ability of an entity to produce more of a good or complete a task in less time compared to other entities. It highlights which party is more efficient in producing a good without necessarily considering the alternative costs. This concept is useful for determining which producer can produce a product at a lower cost of resources in absolute terms.

Terms of Trade

Terms of trade define the rate at which goods are exchanged between parties, ensuring that both parties gain from the trade relative to their opportunity costs. It specifies the price ratio that makes trade mutually beneficial, as long as the rate falls between the opportunity costs of production for the involved parties. This concept ensures that trade leads to a better allocation of resources for all sides involved.

Transcript

00:01 Here we're really looking at how trade can be beneficial.

00:04 And we're looking at a very simple example between two roommates, rather than taking a look at the mass scale of international trade quite yet.

00:10 Here we're just trying to get this idea of what is opportunity cost, what are absolute comparative advantages, and how does all of this impact trade? so let's start with part a here, where we'd like to know what the opportunity cost of making pizza is for both pat and chris.

00:24 So looking at this, for pat, let's start there.

00:27 What we see is that it takes him four hours to brew one, gallon of rip beer and two hours to make a pizza.

00:33 So what we really want to know is the cost of making a single pizza, how many gallons of rip beer is pat giving up to make that one pizza? so what we see here is that one pizza can be made by pat in those two hours.

00:50 And in those same two hours, what could have been done is a half gallon of rip beer.

00:54 And you can see that because it takes four hours for one gallon of rip beer.

00:58 So if we're taking half of the four hours, which is two hours, he would be able to brew half a gallon of rip beer.

01:03 So pat's opportunity cost of making pizza, of making this one pizza would be a half gallon of rip beer.

01:15 So that is pat's opportunity cost of making pizza.

01:19 Now let's do the same thing for chris.

01:21 And we see that chris takes six hours to brew a gallon of rip beer and four hours to make a pizza.

01:27 So her one pizza takes her four hours.

01:32 So within those same four hours that she spent making that pizza, how many gallons of rip beer could she have brewed? well, it looks like it takes her six hours to brew a gallon of root beer.

01:43 So if we take these four hours, we'll divide it by six, right? because we want to know, right, this is her four hours for a pizza, six hours for a gallon of rip beer, dividing them by one another, it gives us 0 .67.

01:59 And what that tells us is that within those four hours of making that one pizza, she could have made 0 .67 gallons of root beer.

02:08 So that would be her opportunity cost here.

02:11 That's chris's opportunity cost.

02:15 Now if we wanted to compare these absolute and comparative advantages, absolute advantage is looking at just who can make the most in the least amount of time.

02:26 So we're looking at it for pizza right now, not for rupeer.

02:30 Let's take a look at pat.

02:32 He takes two hours to make a pizza.

02:35 Chris takes four hours to make a pizza...

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