Question

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Adam and Bobby run a website that produces local news stories and videos.

In one week, Adam can produce 5 stories or 10 videos or any linear combination of the two, while person Bobby can produce 7 stories or 8 videos or any linear combination of the two.

a) Who has the absolute advantage in producing each of the two goods? Explain how you know, and what that means.

b) Who has the comparative advantage in producing each of the two goods? Explain how you know, and what that means.

c) Sketch the production possibility set for one week the two person team.

d) Compared to a situation in which each person worked equally on the two tasks, how much extra could they produce if they each specialized in one task?

e) What factors or forces might the team consider in answering the following normative question: what point in the production possibility set should the team choose?

Answer 1

Solution:

a) A person has an absolute advantage in production of a good when it can produce a higher quanitity of the good as compared to the other person. Adam can produce 5 stories while Bobby can produce 7 stories, so Bobby has an absolute advatage in stories' production. Similarly, Adam can produce 10 videos at max, while Bobby can produce only 8, so Adam has an absolute advantage in video production.

b) A person has a comparative advantage in production of a good if he/she incurrs a lower opportunity cost in production of that good, as compared to other person. Opportunity cost is the amount of one good sacrificed in order to increase production of other good by a unit.

In this case, opportunity cost of producing stories for

Adam = 10/5 = 2 videos

Bobby = 8/7 = 1.14 videos

As opportunity cost of producing stories is lower for Bobby as compared to Adam (1.14 < 2), Bobby has a comparative advantage in stories' production, while Adam has a comparative advantage in videos production.

c) The combined production possibility forntier can be drawn as follows:

Initially, assume both produce only videos, then total of 10 + 8 = 18 videos can be produced.

Then, in order to produce stories, first Bobby will give up on video production, as it has to lose lower video production doing that. This way, for every additional story, Bobby will give up videos, while Adam will continue producing only videos. Finally, when Bobby utilizes entire week in story production, such that we reach the point where Bobby produces all stories that is 7 stories, while Adam produces all videos, that is 10 videos (the kink point). Post this, Bobby will constinue producing 8 stories and none of videos, while Adam starts giving up video production (decreasing 2 videos for every increase in story production), to the point where finally, both produce only stories = 5 + 7 = 12 stories.

This can be drawn as: Blue line is the required combined PPF

d) If each person worked individually on each task, half time:

Adam would end up producing 5/2 = 2.5 stories, and 10/2 = 5 videos

Bobby would end up producing 7/2 = 3.5 stories, and 8/2 = 4 videos

So, total stories = 2.5 + 3.5 = 6 stories, and total videos = 5 + 4 = 9 videos

When working as a team, and specializing in each task, Adam would produce only videos and no story, while Bobby will produce only stories and no video, end up producing at the kink point: 7 stories (> 6 stories) and 10 videos (> 9 videos), so extra of 1 for both the tasks.

e) The point to be chosen on production possibility set should be the one lying above and outside the set when both worked independently on both tasks, such that specialization is fruitful.