Opportunity cost is defined as the benefit that is forgone by forfeiting the next best desirable alternative (Peter & Curwen, 1990). Economists have for a long time studied the opportunity cost principle and various definitions, discussions, and inferences on the topic have been presented. Opportunity cost applies to individuals, households, institutions, or even governments since they all make day to day decisions on consumption, savings, and investments (John, 2006).
Michelle’s Opportunity cost of producing potatoes is the fifty chickens she would have raised per year had she devoted all her resources in raising chicken. This is because, with the available resources at her disposal, she can either raise fifty chickens or produce two hundred pounds of potatoes.
Thus her decision to produce potatoes means she has chosen to forgo the fifty chickens that she would have raised in place of the potatoes. As such, the opportunity cost of raising chickens is the two hundred pounds of potatoes she would have produced had she decided to produce the potatoes. Her decision to rear chickens means that she foregoes the production of potatoes which would have given her two hundred pounds of potatoes.
If James decides to produce potatoes, it means that he has opted to forgo the benefits of raising chickens. Therefore the amount of benefit that he forgoes to pursue his potato production is the opportunity cost of producing potatoes. This is the forty chickens she would have raised in the year. Consequently, if he decides to raise chicken, he forgoes the eighty pounds of potatoes that he would have produced had he decided to produce them. This is James’ opportunity cost of raising chicken.
Absolute advantage is defined as the ability of an individual, institution, or country to produce a certain commodity at a lower cost per unit than that of another person institution, or country (John, 2006). In the above case, Michelle has an absolute advantage over James in the production of both Potatoes and the raising of chicken. This is because, in one year, she can produce two hundred pounds of potatoes as compared to James’ ability to produce only eighty pounds. She is also able to raise fifty chickens per year as compared to James’ ability to raise only forty per year. Therefore Michelle enjoys an absolute advantage over James.
Comparative advantage is defined as the ability of a party to produce an item more efficiently than another party’s (Peter & Curwen, 1990). Michelle has a comparative advantage over James in the production of potatoes since she can efficiently produce more potatoes and exchange them for chicken so as obtain eighty chickens. James has a comparative advantage over Michelle in the production of chickens. This is because he can produce forty chickens in a year compared to the eighty pounds of potatoes whereas Michelle can produce fifty chickens compared to two hundred pounds of potatoes.
Their decision to specialize in the area that they have the comparative advantage they would be better off. This is because if Michelle only produces Potatoes and exchanging them at a rate of 2.5 pounds per chicken, she would end up having an equivalent of eighty chickens. James would as well be better off because if he only raises chicken, he can exchange the chickens at the same rate to have one hundred pounds of potatoes.
The above concept of comparative advantage can be applied to the business world to help businesses and countries identify areas where they can efficiently produce commodities and exchange them with other commodities that they cannot produce efficiently. It is also useful in identifying areas where investments are more favorable than others when it comes to making decisions on where to employ resources.
David, L. (1974). Introduction to Microeconomics. New York: Basic Books.
John, P. B. (2006). Microeconomics: Optimization, Experiments, and Behaviour. New York: Oxford University Press.
Peter, E., & Curwen, P. (1990). Principles of Microeconomics. London: Unwin Hyman.