Question

Basil makes a cup of latte every morning. To make latte, one needs espresso and milk. "There is no substitute for espresso if you want a latte; so, it is not true that there are substitutes for everything!" says his friend. Explain how the friend misunderstands the principle of substitution and how one should think about it correctly

Answer 1

espresso is a key ingredient of coffee, so by substritumting it with another ingredient, it won't be called a latte

Answer 2

Basil's friend misunderstands the principle of substitution by thinking that it implies there are substitutes for every individual component of a product. In economics, substitution is about consumer choice and the trade-off between different goods. Maria and Charlie should specialize in making items for which they have the lowest opportunity cost, which is sandwiches for Maria and lattes for Charlie, illustrating the concept of comparative advantage.

The friend's statement about espresso and lattes misunderstands the economic principle of substitution because it takes the concept in an absolute rather than relative sense. Substitutes in economic terms refer to the possibility of replacing one good with another in response to changes in price or other factors. However, some goods might be considered irreplaceable for a specific use, like espresso in a latte. The principle doesn't imply that every individual component in every situation has a substitute, but rather that consumers can often find substitutes for a general need or desire.

Regarding Maria and Charlie's scenario at the coffee shop, Maria has an absolute advantage in making both lattes and sandwiches compared to Charlie. To determine what they should specialize in, we look at the concept of comparative advantage. Maria's opportunity cost for producing 24 lattes is 8 sandwiches, making the opportunity cost for 1 latte 1/3 sandwich. Conversely, her opportunity cost for producing 1 sandwich is 3 lattes.

Charlie's opportunity cost for producing 5 sandwiches is 10 lattes, making his opportunity cost for 1 sandwich 2 lattes. Thus, Maria should specialize in making sandwiches as she has a lower opportunity cost for them, whereas Charlie should focus on lattes.

Specialization based on comparative advantage ensures that each person is doing the task with the lowest opportunity cost, thus output is maximized, and it is economically advantageous for the coffee shop. This reflects the broader economic principle that entities should focus on the production of goods for which they have a comparative advantage, which leads to greater efficiency and potential gains from trade.