Question

Bill and Fred bake cookies and pies. Bill's opportunity cost of baking 1 pie is 5 cookies. Fred's opportunity cost of baking 1 pie is 7 cookies. If both parties are to benefit from trade then we can expect 1 pie to sell for _____.

Answer 1

Answer:

6 Cookies {or any >5, <7)

Explanation:

Theory of Comparative Advantage states : A person/ economy having lesser opportunity cost (i.e other good sacrifised) to attain a good, should sell it to - other person/ economy having the good's higher opportunity cost.

Trade is beneficial if the terms of trade exchange ratio is better than own account production sacrifise ratio.

Bill can bake a pie with opportunity cost of 5 cookies. Fred can bake a pie with opportunity cost of 7 cookies. Bill has less opportunity cost of Pie in terms of Cookies, so should sell it to Fred.

The trade between them will be beneficial only if : both of them gain from trade - i.e get a good at lower opportunity cost than their own. Fred getting 1 pie per 6 cookies is better than his own sacrifise ratio i.e 1pie : 7 cookies.  Bill getting 1 cookie per 0.16 (1/6) pie is better than his own sacrifise ratio i.e 1cookie : 0.25pie (1/5)