Question

Suppose that the costs of production of winter hats and wheat in two countries are as follows: $$\begin{array}{lcl}\hline & \text { United States } & \text { Russia } \\\\\text { Per winter hat } & \$ 10 & 5,000 \text { rubles } \\\\\text { Per bushel of } & \$ 1 & 2,500 \text { rubles } \\\\\text { wheat } & \end{array}$$ a. What is the opportunity cost of producing one more winter hat in the United States? In Russia? b. What is the opportunity cost of producing one more bushel of wheat in the United States? In Russia? c. Which country has a comparative advantage in winter hats? In wheat?

Short answer

The opportunity cost of producing one more winter hat is 10 bushels of wheat in the US and 2 bushels in Russia. The opportunity cost of producing one more bushel of wheat is 1 winter hat in the US and 0.5 winter hat in Russia. The US has a comparative advantage in the production of Winter hats while Russia has a comparative advantage in the production of wheat.

Step-by-step solution

Calculate Opportunity Cost

Opportunity Cost is calculated by dividing the cost of production of one good by the cost of production of the other good. So, for the United States, the cost of producing one more winter hat is 10 dollars and the cost of producing one more bushel of wheat is 1 dollar. The opportunity cost of producing a winter hat in the US is thus \( \frac{10}{1} = 10 \) bushels of wheat. Similarly for Russia, the opportunity cost of producing a winter hat is \( \frac{5000}{2500} = 2 \) bushels of wheat. Follow the similar process to calculate the opportunity cost of producing one more bushel of wheat.

Determine Comparative Advantage

A country has a comparative advantage in the production of a good if it can produce that good at a lower opportunity cost than other countries. Simply compare the opportunity cost of each good in both countries. The country with the lower opportunity cost for a good has the comparative advantage in the production of that good.

Analyze the Results

The opportunity cost of producing one more bushel of wheat in the US is 1 winter hat, for Russia it is 0.5 winter hat. Thus, Russia has a comparative advantage in the production of wheat. Likewise, comparing the opportunity cost of a winter hat, US has a comparative advantage in the production of winter hats.

Key concepts

Comparative Advantage

In the realm of microeconomics, comparative advantage is a pivotal concept that determines how different countries can engage in beneficial trade by specializing in the production of goods for which they hold a lower opportunity cost compared to others. This principle was famously introduced by David Ricardo in the 19th century and remains instrumental in trade theory.

For example, consider our exercise where we measure the efficiency of the United States and Russia in producing winter hats and wheat. To identify which country has a comparative advantage for each good, we compare their respective opportunity costs. An opportunity cost is essentially what is foregone to produce one more unit of a good, like how many bushels of wheat are given up to produce an additional winter hat. The United States has a comparative advantage in producing winter hats because its opportunity cost of 10 bushels of wheat is lower than Russia's 2 bushels of wheat per hat. For wheat, Russia's opportunity cost of 0.5 winter hat is lower than the 1 winter hat for the US, indicating Russia's comparative advantage in wheat production.

The principle suggests that trade between countries can be most beneficial when each country exports goods for which it holds a comparative advantage, thus maximizing economic efficiency and gains from trade.

Cost of Production

Understanding the cost of production is fundamental in evaluating the efficiency and profitability of producing goods. It encapsulates all the expenses incurred to fabricate a product, including materials, labor, and overhead costs.

In microeconomic principles, the cost of production is also directly linked to the notion of opportunity cost. Through our exercise scenario, we can see that the cost of production in different currencies—dollars for the US and rubles for Russia—can be evaluated to compute opportunity costs for each country. This comparison does not only indicate the monetary cost but also represents the resources (e.g., labor, capital) allocated to produce additional units of goods.

For the United States, the monetary cost of producing one more winter hat is $10, while for Russia it's 5,000 rubles. These costs lead to different opportunity costs when weighed against the production of wheat, highlighting how the absolute costs in currency terms intertwine with resource allocation decisions on a broader level.

Microeconomic Principles

Microeconomics delves into the decisions made by individuals and firms regarding the allocation of resources and the interactions among these entities within the marketplace. It deals with fundamental principles such as supply and demand, elasticity, market equilibrium, and the concept of opportunity cost, among others.

Our exercise exemplifies crucial microeconomic principles at work. By calculating opportunity costs, we are applying the concept of trade-offs, a foundation of decision-making, where choosing to allocate resources for one purpose incurs the cost of not using them for another.

Furthermore, microeconomics focuses on how individuals and businesses respond to changes in costs and how those changes affect market behavior. In trade, these principles help explain why countries might choose to focus on producing certain goods over others, as in the case of the United States and Russia with winter hats and wheat production, leading to specialization and the potential for beneficial trade based on comparative advantage.