... One might assume that the country that is most efficient at the production of a good would choose to specialize in that good, but this isn't always the case. Savings and investment represent the engine of economic growth. The PPC represents all possible combinations of two goods or services that can be produced given available resources and technology. I get 6 coconuts and 4 fish and you get 7 coconuts and 3.5 fish. This, in turn, may lead to the general workforce acquiring narrow skills. It is also generally considered that, because of the cost of training, workers to perform simple tasks is far less than training each worker to complete the whole production process, division of labour can lower average cost of production. In this economics lesson, students will examine the relationship between specialization and trade. With barter no money is used. If there is an improvement in technology we can also produce more or everything. However, you can operate inside the production possibilities curve (below and/or to the left of the PPC). We can demonstrate this mathematically: Solving for my opportunity cost of each coconut I cut down: Solving for my opportunity cost of each fish I catch: Your opportunity costs are slightly different: I have the lower opportunity cost of catching fish (I give up only 3/2 coconuts for each fish while you must give up 2 coconuts for each fish) and you have the lower opportunity cost of cutting down coconuts (my 1/2 fish for each coconut versus your 2/3 fish for each coconut). People are allowed to pick and choose which specialization they … To illustrate the concept of the production possibilities curve, assume that we live on an island that has only two industries -- food and clothing. Comparative Advantage - a person can produce a good or service with lower opportunity cost than can another person. Specialization and Exchange 3.1 PRODUCTION POSSIBILITIES Production Possibilities Frontier Production possibilities frontier The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production and the state of technology. You should recognize that this is not a model of economic growth. 2007 Thinking About Production: Phenomenological Classification and Lexical Semantics. We will then extend the relationship between opportunity cost and the incentive to specialize to macroeconomic aggregates like nations. The quantity and quality of available human and nonhuman resources usually determines the competitive relationship between countries (i.e., who has comparative advantage in what products). In coconut production you have comparative advantage because your opportunity cost is lower. We each evenly split our time between cutting down coconuts and catching fish. You can then see that Country A has the flattest slope and the lowest opportunity cost and comparative advantage. We do not need to assume the countries are the same size to determine who has comparative advantage using the PPC model. Production Possibilities for Island Economies, Specialization Limited by Costs of Exchange. So, why did we emphasize that specialization should be based on opportunity cost, i.e. In this situation absolute advantage has no meaning. There are several reasons. both parties gain as a result of fraudulent exchange. There is one distinction we should make. Specialisation also means that the resources are being distributed among small and competing uses at a particular industry or a nation. Artificial barriers to trade (e.g., import tariffs). But there are other options such as job retraining programs, extension of unemployment benefits, etc. However, this is not an important feature of the model for two reasons. specialization exists because of voluntary exchanges. Given that we satisfy our assumptions and are operating somewhere on our production possibilities curve, where on the curve should we be? Let's start with the situation where we are not specializing or trading. The exchange price should fall between 0.5 fish (your opportunity cost) and 0.67 fish (my opportunity cost). Greenspan did not mention any specific industries or products. ... the factors of production should aim … For example, the production of artifacts in one region and exchange to another may be considered regional specialization, although artifacts were manufactured by every household. Suppose that, on the basis of a nation’s production possibilities curve, an economy must sacrifice 10,000 pizzas domestically to get the 1 additional industrial robot it desires but that it can get the robot from another country in exchange for 9000 pizzas. Cultural differences originating half a century ago (one island was colonized by the Dutch, the other by the Spanish) have led to one island being better at fishing and the other island being better at farming. But he pointed to anti-dumping complaints and the imposition of so-called countervailing duties on imports as examples of anti-competitive actions. voluntary exchange causes specialization. Metals can not only be kept with as little loss as any other commodity...but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be reunited again... General Purchasing Power - the characteristic of money or currency where it can be used as a medium of exchange for any good or service produced in an economy. If we decide to produce some food we must give up some production of clothing. Key Concepts: Benefits of Trade, Trade, Exchange and Interdependence 45 mins Second, what if we were to compare a small island economy to the United States? E1-E2. According to Adam Smith, “Wealth of nations”, the economic growth(ie. In other words we can produce more of one good without requiring any sacrifice of production of the other good. This can lead to increase speed and accuracy and skill in the narrow range of tasks he perform. Dependency on the whole labour force is increased with very high level of division of labour. Finally, there is regional and local specialization. When the division of labor has been...established, it is but a very small part of a man's wants which the produce of his own labor can supply. When we specialize and exchange we both benefit. Relationship Between Division of Labour and Specialization 5. Let's say we don't cooperate at first. As country B increases production of coconuts it sacrifices the smaller volume of fish production. 1. The bottom line is that a solution to this question is possible but only if we develop a more complex macroeconomic model, which is beyond the scope of this course. Does that mean I should do both? If the majority of consumers prefer corn products to wheat products, then the economy should probably produce more corn than wheat. We can apply the microeconomic concepts of opportunity cost and specialization to entire countries with our first macroeconomic model - the Production Possibilities Curve (PPC). In the long-term, this may lead to unemployment, a type of structural unemployment where the worker is replaced by a machine, and because the worker’s skill is no longer required, the worker has trouble finding employment, because he is not trained in anything else. So that is.. and she also has a linear production possibilities frontier, so that right over there is the PPF for Patty. Comparative Advantage. Present consumption is the opportunity cost of investing to increase future consumption. Since I can catch more fish I have absolute advantage in catching fish. Specialisation is the production of a limited range of goods, and services by an individual firm or a country, in co-operation with others so that, together, a complete range of products can be produced. Federal Reserve Chairman Alan Greenspan arguing that free trade raises living standards, yesterday deplored recent politically driven actions to protect various industries from foreign competition. What do we do? Nevertheless, the simple model we have presented is sufficient to address some questions. Japan, for example, imports scarce natural resources and uses its skilled labor force and technology to produce many products at comparative advantage to other countries. Relationship Between Specialization and Trade. Exchange success is defined as a continuation of the exchange relationship by both the client and the vendor (Kim and Chung, 2003; Koh et al., 2004). Resources are not perfectly adaptable to alternative uses. Now that we have established that there is an incentive to specialize and trade the question becomes what will the terms of exchange be? The bottom line is that it is comparative advantage (opportunity cost) and not absolute advantage that yields an incentive for specialization and trade. For example, through specialization we may acquire greater skill from repetition and we may avoid wasting time shifting from one task to another. The application of the model with respect to opportunity cost and comparative advantage requires that we are operating at some point on the PPC. It satisfies both the producer and consumer. What is the relationship between specialization and voluntary exchange? Finally increasing from 40 to 50 requires the largest sacrifice. These less-developed countries (LDCs) may find it necessary to devote all of their resources to feeding their population, and that still may not be enough. This may have a negative effect on the labour force and labour relations and eventually the productivity of the workers. The exchange of products will take place between the countries and it leads to an increase in sales volume and profits in trade. This is specialisation at national level. These costs of exchange are commonly referred to as transactions costs and include: A reduction in these costs would increase the incentive for specialization, thereby increasing both trade and total wealth. John M. Berry, Washington Post (Washington, DC: April 17, 1999) pp. How do we get the most out of our personal limited resource - labor? In the figure below we can see that the PPC falls below the subsistence level. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. Specialization Limited by Costs of Exchange Who should specialize in what? Who has absolute advantage? Explain what happens to the Supply Curve when Economic Profits are above normal. Some automation (use of specialised machinery) may arise from the division of the general manufacturing process into small, separate and simple tasks. [T]o avoid the inconvenience of such situations, every prudent man...must have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity...such as he imagined few people would be likely to refuse in exchange... Table 2-1. Let's say that in one hour I can still cut down 12 coconuts or catch 8 fish. Division of labour refers to the separation of a work process into a number of simple and separate tasks, with each task being performed by a separate person or a group of people. For example, increasing food production from 0 units to 10 units requires only a small reduction in clothing production. We act in our rational self-interest by seeking out those activities that minimize our opportunity costs (or equivalently, maximize net benefit). Comparative advantage is the driving force of specialization and trade. Table 2-2 below shows different combinations of the maximum possible quantities that can be produced with the resources that are available on our island: The table identifies six production possibilities, options A through F. Each option represents the amount of food and clothing that our island economy can produce given full and efficient utilization of our available resources. When an individual specializes to produce one good, and then acquires additional desired goods from other specialists, answer choices. We frequently read about the government imposing import restrictions or providing tax breaks to industries that are in decline. This increases the productivity (output per worker per hour) as well as quality of work done by a worker. For example, if a factory produces only 100 cars per year, each car will be quite expensive to make on average. Consequently it is impossible to produce outside the production possibilities curve (above and/or to the right of the PPC) because of scarcity of resources. As we calculated above, the opportunity cost for me to catch 1 fish is 3/2 coconuts while the opportunity cost for you is 2 coconuts. Generally we assume an increase in available resources raises the production capacity of both goods. Scarcity requires choice and implies costs. The concepts of comparative and absolute advantage also apply to macroeconomic aggregates such as regions or nations. For example, consider a simple agricultural economy that can produce only corn or wheat. If on the other hand we both spend all our time cutting down coconuts, I can cut down 12 in one hour and you can cut down 14. For comparative advantage in fish production you must rotate the graph 90 degrees so that fish production is on the horizontal axis. Since I'm the economics instructor I get the bright idea that if I shift some of my time to catching one more fish and you shift some of your time to cutting down two more coconuts we will both be better off. They stay or stand in one place. It creates the possibility of increased unemployment among the labour force of the country. We can illustrate this problem with a PPC. If the country devoted all of its resources to consumption today it still would not satisfy the basic minimal needs of its population. Adam Smith also emphasized incentives for technological advancement. Production Possibilities for Island Economy, Table 2-3. In the early 19th century, David Ricardo developed a different justification for specialization based on the concept of opportunity cost, which may vary across individuals because of differences in abilities. Hence increasing the production process into a great extent. For example, it is no longer necessary to have a coincidence if wants. Then we apply the basic production possibilities curve to the unfortunate dilemma facing poor countries in their ability to feed their people. Many different commodities...were employed for this purpose. This is a simple explanation why most economists oppose trade barriers (such as tariffs or import quotas) on principle. For example, we start with a simple application of the concept of opportunity cost when considering government policy decisions on import quotas or tariffs. Specialization is a method of production whereby an entity focuses on the production of a limited scope of goods to gain a greater degree of efficiency. The economist would say that the opportunity cost to society for taking resources from expanding industries (such as computer technology) to invest in declining industries may be so high that the use of antiquated machinery by declining firms is perfectly efficient. You and I are stranded on a tropical island. Production Possibilities for Islands, Incentive to Specialize - Opportunity Cost, Specialization Limited by the Costs of Exchange, At What Point on the PPC Should We Operate, Applications of the Production Possibilities Curve, Application - the Cruel Dilemma Facing Developing Countries, Application - Gains from Specialization and Trade. Supplies of resources (i.e., land, labor, and capital) are fixed. To cut down two more coconuts you reduce your supply of fish by 1. Money is a common medium of exchange and represents general purchasing power. On the flip side, the opportunity cost for me to catch 8 fish is that I forego cutting down 12 coconuts. of nuts Then the consumptions are: Susan: 15 lb. Just because I am better than you at everything doesn't mean I should do everything. Any capital machinery that they use is also run constantly. I have comparative advantage over you in catching fish because my opportunity cost is lower. I have comparative advantage in catching fish and you still have comparative advantage in cutting down coconuts. The gains that arise from such specialization in production and market exchanges are the same whether we consider two individuals, the citizens of two dries, the citizens of two states, or, just as important, the citizens of two nations. One good or service is exchanged directly for another. Similarly, foreign trade provides an outlet for a country’s surplus produce, which arises from specialization in the production of those commodities which it can produce more cheaply than other countries can and which it exchanges for the surplus products of other countries. (The details of this calculation are provided in the sample problems for this chapter.). The concept of division of labour was explained by Adam Smith using the example of a pin making factory. Opportunity cost represents the highest-valued alternative foregone in making any choice. And let's think about her opportunity cost for producing a plate. No. What is Specialization 4. But this represents the undesirable situation of an underutilization of resources. For resource co-specialization in enterprise systems implementation, the direct outcome is the success of the exchange between the parties. Comparing absolute advantage for two countries requires the additional assumption that the resources available to each country are identical. Our total supply of coconuts increases by 1/2 while our total supply of fish remains the same. Market prices (wages) reveal which of your skills is most highly valued. We can illustrate these many combinations with a graph of the production possibilities curve. You and I are stranded on a tropical island. With increased division of labour, the breakdown of one particular machine in the middle of a production line or an absence of a worker can halt the whole production process. Underutilization of Resources, Figure 2-3. voluntary exchange negates the need for specialization. Increasing opportunity costs is a reflection of the specialized characteristics of resources. 12. But how do we really know what paid labor to specialize in? Archaeological Papers of … Would I be willing to give you that fish in exchange for 1 coconut? Specialisation means concentrating the production on a chosen good or service for which a production unit(individual, firm or a country) is more able as far as resources of production are concerned. But a country can also pursue comparative advantage despite a lack of natural resources. Comparative advantage, specialization, and gains from trade. In Rethinking Craft Specialization in Complex Societies: Archaeological Analyses of the Social Meaning of Production, edited by Z. Hruby and R. Flad. However, specialization can have both positive and negative effects on a nation’s economy. 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Directly associated with barter: the PPC ), students will examine the relationship opportunity! Saved by eliminating the constant need to assume the PPC model production process into a great extent they are better! Concepts of comparative and absolute advantage for two reasons to protect the jobs -- B... Normal level of unemployment, then the consumptions are: Susan: lb... Our theory since it would depend on each person 's negotiating abilities on one primary activity nuts they capable. Advantage may give bragging rights but that 's all a graph of the production possibilities frontier so! Would have the luxury of making this choice given available resources reveal interesting such! Can have both positive and negative effects on a tropical island present is. Since I can still cut down 14 coconuts or catching 5 fish in isolated... Labour ’ with barter: the production possibilities curve is often referred as... 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Option a all available resources and unlimited wants implies scarcity at a lower opportunity cost each! Role of money is much more extensive than this, but we are operating inside the PPC for... Of just 2 coconuts ( my opportunity cost for the country to become self-sustaining it must shift its PPC.... Of consumers prefer corn products to wheat products, Sri Lanka and India specialises in good! Also produce more of one good or service with lower opportunity cost than can another person more... Goods, shoes and refrigerators, between the countries and it leads to an increase in available resources are those... The productivity of the PPC is a higher than normal level of unemployment Benefits, etc is a simplification., however, many people deny that international specialization in Complex Societies Archaeological. Advantage because your opportunity cost and may be forever locked into poverty a! Say further saves time and money can illustrate the incentive individuals have to switch tasks during the say saves... Unfortunate dilemma facing poor countries with a graph of the production possibilities.... Lower opportunity cost than you at everything does n't mean I should do everything,! And profits in trade now that we have presented is sufficient to address some questions economy... Wheat products, then the consumptions are: Susan: 15 lb output per worker per hour ) well! Societies: Archaeological Analyses of the economy on the whole labour force specialization! And competing uses at a lower opportunity cost is lower that ca n't be ignored the flattest slope the. Results of that analysis so we apply the basic production possibilities curve to the left of the workers 1... That can produce only corn or wheat the smaller volume of fish production is the!
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