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Suppose there are two individuals, Casey and Rick, who live in a very simplified world where only two goods are produced and consumed: steak and potatoes. The production opportunity cost for Casey is 5.00 kg of steak for every kilogram of potatoes. Rick has a production opportunity cost of 3.00 kg of steak for every kilogram of potatoes. Casey eventually realizes that, through trade, both individuals can be better off. Rick is willing to trade. What price can be settled between these two parties such that both individuals can enjoy more steak and potatoes

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Answer:

Casey's opportunity cost of producing 1 kg of potatoes is 5 kg of steak.

Casey's opportunity cost of producing 1 kg of steak is 0.2 kg of potatoes.

Rick's opportunity cost of producing 1 kg of potatoes is 3 kg of steak.

Rick's opportunity cost of producing 1 kg of steak is 0.33 kg of potatoes.

Casey should produce steak while Rick should produce potatoes, since Rick has a comparative advantage in producing potatoes (lower opportunity cost) and Casey has a comparative advantage in producing steak.

As long as the price of steak per kilogram of potatoes is less than 5 kg of steak and more than 3 kg of steak, then both would win. In order for both of them to win is a similarly proportional way, the exchange price should be 4 kg of steak per kg of potatoes.

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