Question

Tony and Patry produce skis and snowboards. The tables show their production possibilities. Tony produces 5 snowboards and 40 skis a week; Patty produces 10 snowboards and 5 skis a week. Who has a comparative advantage in producing (i) snowboards and (ii) skis? b. If Tony and Patty specialize and trade 1 snowboard for 1 ski, what are the gains from trade?

Short answer

Patty has a comparative advantage in producing snowboards, while Tony has a comparative advantage in producing skis. Both benefit from trading 1 snowboard for 1 ski.

Step-by-step solution

- Determine Production Efficiency

Calculate the opportunity cost for Tony and Patty in producing one additional snowboard and one additional ski. For Tony, the opportunity cost of producing one snowboard is the number of skis he can produce in the same time. That is 40 skis / 5 snowboards = 8 skis per snowboard. For Patty, the opportunity cost of producing one snowboard is 5 skis / 10 snowboards = 0.5 skis per snowboard.

- Compare Opportunity Costs for Snowboards

Tony's opportunity cost for producing one snowboard is 8 skis, while Patty's opportunity cost for producing one snowboard is 0.5 skis. Since Patty's opportunity cost is lower, Patty has a comparative advantage in producing snowboards.

- Compare Opportunity Costs for Skis

For Tony, the opportunity cost of producing one ski is 5 snowboards / 40 skis = 0.125 snowboards per ski. For Patty, the opportunity cost of producing one ski is 10 snowboards / 5 skis = 2 snowboards per ski. Since Tony's opportunity cost is lower, Tony has a comparative advantage in producing skis.

- Determine Gains from Trade

If Tony and Patty trade 1 snowboard for 1 ski, each will benefit as they can now consume beyond their original production possibilities. Tony can trade some of his surplus skis for snowboards at a favorable rate, and Patty can trade her surplus snowboards for skis at a favorable rate.

- Conclusion of Gains from Trade

Tony benefits from this trade because he can gain snowboards by giving up fewer skis than if he produced them himself. Similarly, Patty benefits because she can gain skis by giving up fewer snowboards than if she produced them herself. Thus, both will be better off through specialization and trade.

Key concepts

Opportunity Cost

Opportunity cost is a key concept in economics that involves the next best alternative that must be given up to do something. In simplified terms, it’s about what you lose when you make a choice. For instance, if Tony chooses to produce one snowboard, he must give up the production of 8 skis. Conversely, if Patty chooses to produce one snowboard, she must give up only 0.5 skis. This indicates that producing one product over another carries a specific 'cost' in terms of what else could be produced. Calculating opportunity costs helps to identify who has the comparative advantage in producing specific goods, ultimately guiding decisions about specialization and trade.

Production Efficiency

Production efficiency refers to the ability to produce goods at the lowest possible cost while utilizing all resources. Tony is highly efficient in producing skis, and Patty is highly efficient in producing snowboards. Efficiency in production means maximizing output with the given resources.
When determining production efficiency, we calculate the opportunity cost to see how many units of another good must be sacrificed to produce one more unit of the chosen good. In this scenario, Tony can produce a ski at a lower opportunity cost (0.125 snowboards per ski) compared to Patty. So, Tony is more efficient in ski production. Similarly, Patty can produce snowboards at a lower opportunity cost (0.5 skis per snowboard) compared to Tony, making her more efficient in snowboard production.
Production efficiency guides decisions about how to allocate resources for maximum output and minimal waste.

Trade Gains

Trade gains arise when individuals or entities specialize in the production of goods where they have a comparative advantage and then engage in trade. By trading, they can both achieve consumption levels that were not possible through their production alone. In the context of Tony and Patty, by specializing and then trading 1 ski for 1 snowboard, they both benefit.

• Tony can trade his efficiently-produced skis for more snowboards than if he had made them himself.
• Patty can trade her efficiently-produced snowboards for more skis than if she had made them herself.

This trade allows both to consume beyond their production possibilities, showing that through specialization and trade, overall welfare can be significantly increased.

Specialization

Specialization involves focusing on the production of a limited scope of goods to gain greater efficiencies. When Tony and Patty specialize, Tony focuses on producing skis, where he has a comparative advantage, and Patty focuses on producing snowboards, where she has a comparative advantage. This allows each to make the most efficient use of their resources.
Specialization leads to more effective production and higher total output. When each person or entity specializes and trades their surplus, both can benefit from goods they did not produce themselves, enhancing overall productivity and efficiency. By trading 1 ski for 1 snowboard, both Tony and Patty enjoy the benefits of specialization, producing more efficiently and trading to obtain what they need at a lower opportunity cost.