Suppose that Dwight and Jim can either make salads or grill steaks.Their maximum output per hour is listed in the following table.Given the same quantity of resources,at what terms of trade (relative price ratio)could they specialize and trade so that both consume outside their own production possibilities frontier (PPF)?
A)1 salad per 1 steak
B)2 salads per 1 steak
C)2.5 salads per 1 steak
D)3 salads per 1 steak
E)3.5 salads per 1 steak

Question

Suppose that Dwight and Jim can either make salads or grill steaks.Their maximum output per hour is listed in the following table.Given the same quantity of resources,at what terms of trade (relative price ratio)could they specialize and trade so that both consume outside their own production possibilities frontier (PPF)? 
A)1 salad per 1 steak 
B)2 salads per 1 steak 
C)2.5 salads per 1 steak 
D)3 salads per 1 steak 
E)3.5 salads per 1 steak

Quizplus · Accepted Answer

To determine the terms of trade that would allow both Dwight and Jim to consume outside their PPFs, we need to find their respective opportunity costs for producing salads and grilling steaks. The opportunity cost of a good is the amount of the other good that must be given up to produce one unit of it.

For Dwight:
Opportunity cost of producing 1 salad = 2/3 steak 
Opportunity cost of producing 1 steak = 1.5 salads

For Jim:
Opportunity cost of producing 1 salad = 1/2 steak 
Opportunity cost of producing 1 steak = 2 salads

Based on these opportunity costs, we can see that Dwight has a comparative advantage in producing steaks because his opportunity cost of producing one steak (1.5 salads) is lower than Jim's opportunity cost (2 salads). Similarly, Jim has a comparative advantage in producing salads because his opportunity cost of producing one salad (1/2 steak) is lower than Dwight's opportunity cost (2/3 steak).

To consume outside their PPFs, they should specialize in producing the goods that they have a comparative advantage in and trade with each other. Specifically, Dwight should specialize in producing more steaks and Jim should specialize in producing more salads. By doing so, Dwight can trade some of his steaks for salads with Jim, and Jim can trade some of his salads for steaks with Dwight. As long as the terms of trade (the relative price ratio of salads and steaks) fall between their opportunity costs, both Dwight and Jim will be better off.

In this case, the terms of trade that fall between their opportunity costs are:
Dwight's opportunity cost: 1.5 salads per steak
Jim's opportunity cost: 0.5 salads per steak
Therefore, a terms of trade of 2.5 salads per steak (or any value between 1.5 and 2.5 salads per steak) would allow both of them to consume outside their PPFs.

Suppose That Dwight and Jim Can Either Make Salads or Grill