You have absolute advantage in coconut production. A futher increase from 10 to 20 requires a larger sacrifice. Just as individuals are limited by the scarcity of time and other personal resources, societies are also constrained in their capacity to produce goods and services from their available resources of land, labor, and real capital. In the figure below we can see that the PPC falls below the subsistence level. 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). What is the relationship between specialization and voluntary exchange voluntary exchange allows people to decide what and when they want to buy and sell, rather than forcing them to buy or sell. Now that we have established that there is an incentive to specialize and trade the question becomes what will the terms of exchange be? If the country devoted all of its resources to consumption today it still would not satisfy the basic minimal needs of its population. Each problem often requires the unique application of some part of the theory. For me to produce one more fish you must be willing to give me at least 1.5 coconuts. Ricardo's theory is the subject of this chapter because it goes beyond explaining specialization by individuals to justify why countries (macroeconomies) also specialize and engage in trade. For example, the most fertile land is first transferred from raising sheep to growing food. Whenever a country has a comparative advantage in production it can benefit from specialization and trade. There are many advantages and disadvantages to specialisation, which became common place during the industrial revolution with the creation of factories and the use of division of labour. Archaeological Papers of … An improvement in technology, however, may be specific to one product. Full and efficient use of all available resources. the increase in the value of goods produced in a country in a year) of a county lies in the concept of division of labour. But there are other options such as job retraining programs, extension of unemployment benefits, etc. However, 10 workers working together specialising in the production of pins will produce 48000 pins a day. No exchange can...be made between them. Would you be willing to give me 3 coconuts? When we specialize we tend to concentrate our labor on one primary activity. In this chapter we will use the principle of opportunity cost to justify the incentive individuals have to specialize in their labor. Any capital machinery that they use is also run constantly. Now I have absolute advantage in both coconut and fish production since I can cut down more coconuts and catch more fish in one hour than you can. Does that mean I should do both? You should recognize that this is not a model of economic growth. As country B increases production of coconuts it sacrifices the smaller volume of fish production. Competition and lower prices: Increased competition for domestic producers acts as an incentive to minimize costs and to be innovative to remain competitive. Variety: consumers have improved access to a greater variety of goods and services and thus, have better choice both from their economy and production of other countries. He pointed out that a worker will be able to make 20 pins a day if he were to do all the tasks of pin production himself. Because goods and services are produced from scarce resources, goods and services are also scarce. Higher output: the total output of goods and services will increase and the quality of goods and services produced will increase. The production possibilities curve illustrated above has two significant characteristics: The PPC is "bowed outward" (concave) from the origin. As described earlier, total world production and consumption can be increased through specialization and trade. specialization exists because of voluntary exchanges. To catch one more fish I reduce my supply of coconuts by 3/2. In the rude ages of society, cattle are said to have been the common instrument of commerce...The armour of Diomede, says Homer, cost only nine oxen; but that of Glaucus cost an hundred oxen. These goods are homogeneous, meaning that consumers and producers cannot differentiate between shoes from Mexico and shoes from the U.S.; nor can they differentiate between Mexican or American refrigerators.From Table 1, we can see that it takes four U.S. workers to produce 1,000 pairs of shoes, but it takes five Mexican workers to do so. There are two key terms used to describe the differences in production capabilities of two individuals: absolute advantage and comparative advantage. 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. Their annual production capabilities are represented in Table 2-3: These production possibilities can be graphed as production possibilities curves: There are several things you should observe from the graph: The production possibilities curves for both islands are straight lines. It is comparative advantage that reveals incentives to specialize. But when the division of labor first began to take place, this power of exchanging must...have been [difficult]...The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. There are several problems with barter: The introduction of money reduced the difficulty or costs of barter. Savings and investment represent the engine of economic growth. Poor countries with a hungry population may be unable to pay that cost and may be forever locked into poverty. To illustrate the concept of the production possibilities curve, assume that we live on an island that has only two industries -- food and clothing. Production Possibilities for Island Economies, Specialization Limited by Costs of Exchange. 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. So, why did we emphasize that specialization should be based on opportunity cost, i.e. Just because I am better than you at everything doesn't mean I should do everything. For example, if there is a higher than normal level of unemployment, then our economy is not producing at its full capacity. Increasing opportunity costs is a reflection of the specialized characteristics of resources. So that is.. and she also has a linear production possibilities frontier, so that right over there is the PPF for Patty. Scarcity requires choice and implies costs. It may be easier to demonstrate by slightly changing the example. Specialization is related to another economic concept, division of labor, discussed at great length by Adam Smith, the 18th-century … While economists may feel comfortable with the argument that specialization with free trade would make everyone better off, politics is not so lucky. Straight-line PPCs (constant opportunity cost) - each country completely specializes, Bowed outwards PPCs (increasing opportunity cost) - degree of specialization depends on other market factors (i.e., demands and prices) - not covered in text. A bigger market: specialisation and international trade increases the size of the market, offering opportunities for large-scale of production for a larger market. Relationship Between Division of Labour and Specialization 5. In manufacturing, the advantages of both are best realized through specialization of plants and, in some cases, of enterprises. With additional information about the tastes and preferences of the consumers in our economy we can determine what combination of output maximizes our total satisfaction. There is one distinction we should make. When we specialize and exchange we both benefit. An assembly line, where individual workers perform specific tasks in the production process, is the best example of specialization. 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. This, in turn, may lead to the general workforce acquiring narrow skills. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could...make upwards of 48,000 pins in a day. a curve that does not shift. The production possibilities curve is often referred to as a "Frontier". I have comparative advantage in catching fish and you still have comparative advantage in cutting down coconuts. Specialisation also means that the resources are being distributed among small and competing uses at a particular industry or a nation. I would to thank the writer of this topic of division of labour for good explanation which gave me courage , i had thanks him or her for the knowledge he /she spread to whole world . Our first assumption that only 2 goods or services are produced allows us to illustrate our model as a graph with the output of one economic good plotted against the output of a second economic good. Opportunity cost represents the highest-valued alternative foregone in making any choice. He supplies the greater part of them by exchanging that surplus...of his own production, which is over and above his own consumption, for...the produce of other men's labor...Every man thus lives by exchanging, or becomes in some measure a merchant. What is the relationship between specialization and voluntary exchange? But why is specialization efficient? Fixed factors are those that do not change as output is increased or decreased, and typically include premises such as its offices and factories, and capital equipment such as machinery and computer systems. We suggested that individuals and nations have an incentive to specialize but should they concentrate on producing only 1 product? No. We can continue this logic and show in Table 2-1 that the total supply and consumption of coconuts and fish is greatest when we specialize and I only catch fish and you only cut down coconuts and we trade. of coffee and 6.5 lb. of coffee and 4.5 lbs of nuts They are both better off, compared with the no specialization and no trade situation!! When an individual specializes to produce one good, and then acquires additional desired goods from other specialists, answer choices. But now let's assume we are talking about two Caribbean islands with essentially the same population and natural resources. We can apply the microeconomic concepts of opportunity cost and specialization to entire countries with our first macroeconomic model - the Production Possibilities Curve (PPC). The application of the model with respect to opportunity cost and comparative advantage requires a stable PPC, i.e. Let's say that in one hour I can still cut down 12 coconuts or catch 8 fish. In this situation the PPC shifts outward only along one axis (Figure 2-4). The questions and problems we face are seldom the same. They stay or stand in one place. Of course there are many thousands of goods and services that are supplied in any economy. Section 3 develops the Comparative Advantage - if two agents (countries) have different opportunity costs of producing a good or service, the agent with the lowest opportunity cost has comparative advantage in that good or service. Comparative Advantage - a person can produce a good or service with lower opportunity cost than can another person. This implies opportunity costs are constant. Usually this is not the case but this is a convenient assumption for this example. For example, if a factory produces only 100 cars per year, each car will be quite expensive to make on average. The opportunity cost for me to cut down 12 coconuts is that I give up the opportunity to catch 8 fish. Only 2 goods or services (or aggregates of goods or services) are produced. [A]n example...the trade of the pin-maker; a workman not educated to this business (which the division of labor has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labor has probably given occasion), could scarce...make one pin in a day, and certainly could not make twenty. 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. One political response as mentioned is to protect the jobs. 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. For comparative advantage in fish production you must rotate the graph 90 degrees so that fish production is on the horizontal axis. It satisfies both the producer and consumer. The exchange price should fall between 0.5 fish (your opportunity cost) and 0.67 fish (my opportunity cost). The country whose production possibilities curve crosses each axis at the farthest point has absolute advantage. Declining industries means some must lose their jobs. All of these forms of specialization imply an exchange economy. of nuts Then the consumptions are: Susan: 15 lb. Thus the price of fish must lie somewhere between 1.5 and 2 coconuts. The slope of the PPC becomes more negative as we move from left to right on the curve. If we decide to produce some food we must give up some production of clothing. John M. Berry, Washington Post (Washington, DC: April 17, 1999) pp. ! No, because you could produce 1 more fish by giving up production of just 2 coconuts (your opportunity cost). Those people may also be ill-trained to find work in industries that enjoy a comparative advantage. What "price" should I charge for the fish I produce? On the flip side, the opportunity cost for me to catch 8 fish is that I forego cutting down 12 coconuts. Another reason is that, time is saved by eliminating the constant need to move from one operation to the next by the worker. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Ceramic production and community specialization 73 Craft specialization can be organized under direct state control (as demonstrated through archaeological examples such as the Inka empire: Earle 1987) or outside the domain of administrativeproduction at the household or community level. For example, consider a simple agricultural economy that can produce only corn or wheat. Specialization and trade is called a positive sum game because we both are better off after exchange than we were before. Humanitarian aid would be required. In other words we can produce more of one good without requiring any sacrifice of production of the other good. Resources are not perfectly adaptable to alternative uses. The exchange price should fall between 0.5 fish (your opportunity cost) and 0.67 fish (my opportunity cost). Adam Smith also emphasized incentives for technological advancement. The Food-Clothing Production Possibilities Curve, Figure 2-2. These resource factors include: The availability of natural resources is of course a major determinant of comparative advantage. I have comparative advantage over you in catching fish because my opportunity cost is lower. Even though money eliminates the costs directly associated with barter there still remain some costs of exchange that reduce the benefits of specialization. The opportunity cost of each fish is 3/2 coconuts. For example, through specialization we may acquire greater skill from repetition and we may avoid wasting time shifting from one task to another. We've saved examples of applications for last to show how the theory developed in this chapter can be applied at different levels. Comparative Advantage. The bottom line is that it is comparative advantage (opportunity cost) and not absolute advantage that yields an incentive for specialization and trade. In this situation absolute advantage has no meaning. In other words, it means producing what we produce best. 12. The article is organized as follows: Section 2 presents stylized facts of African international trade and defines a specialization rule. 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. In our simple economy the price will be some number of coconuts. For example, during the 1970s many blamed the plight of the economy on the slow decay of some heavy industries such as steel. Who has absolute advantage? Example, the specialisation of teachers in different subjects in CHSE. Similarly, if resources are not efficiently used we could increase output of one good without sacrificing output of the other good. Assume the country produces only two goods: consumption goods and capital goods. Increased specialization ultimately leads to higher standards of living for all those involved in economic exchanges. For example, we start with a simple application of the concept of opportunity cost when considering government policy decisions on import quotas or tariffs. The opportunity cost of each coconut is 2/3 fish. At What Point on the PPC Should We Operate. We both have an incentive to specialize and trade. Specialisation by individual is called ‘division of labour’. The application of the model with respect to opportunity cost and comparative advantage requires that we are operating at some point on the PPC. 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. 2007 Thinking About Production: Phenomenological Classification and Lexical Semantics. If there is an increase in the resources available (e.g., an increase in the size of the labor force) we can produce more. Competition will help to keep the prices lower in the economy. labor (with consideration of the education and skills of the workforce and the extent of specialization), natural resources such as fertile fields, minerals, navigable waterways, forests, etc., and. 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.). Recall that the combination of limited resources and unlimited wants implies scarcity. One good or service is exchanged directly for another. We frequently read about the government imposing import restrictions or providing tax breaks to industries that are in decline. Our second assumption requires the full and efficient use of all available resources. A scarce resource used to satisfy one need means there is some other need that cannot be satisfied. The actual price of exchange cannot be determined by our theory since it would depend on each person's negotiating abilities. But we are not really interested in absolute advantage. an impoverishing specialization in the first period (current specialization) to an enriching global exchange through an optimization of the values chain by industrialization. Let's say we don't cooperate at first. In this example Island A has absolute advantage in fish while Island B has absolute advantage in coconuts. There is no gain from trade; exchange simply makes possible the specialization of labor, which is the source of increased production. You would only be willing to exchange if you could give me less than 2 full cocunuts. One of the most important choices any society (and individual) makes deals with the tradeoff between enjoying consumption today and investing for a greater level of consumption tomorrow. Specialization: Specialization is defined as the concentration of the productive efforts of an individual, a firm or a country in a given aspect of economic activity or on a particular line of production in which it has the greatest advantage over others. There are several reasons. In option A all available resources are dedicated to the production of clothing. A major drawback of division of labour is, boredom and alienation, which people may experience when carrying out very simple repetitive tasks. Options B through F represent progressively increasing output of food and decreasing output of clothing. Comparative advantage is based on opportunity cost. 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. Quite simply by what pays you the most for your training and abilities. This country faces the cruel dilemma that it cannot invest in the equipment needed to boost future productivity and consumption without letting more people go hungry today. There is still a human element (voters) that can't be ignored. The country that has the lowest opportunity cost for producing coconuts is the one with the flattest curve -- Country B. Hence increasing the production process into a great extent. Our total supply of coconuts increases by 1/2 while our total supply of fish remains the same. Individuals seek those jobs they are capable of performing and that pay the highest wage or salary. Explain the relationship between Diminishing Marginal Utility and the Demand Curve. How do we get the most out of our personal limited resource - labor? Review graphs of two countries with different PPCs. Comparative advantage, specialization, and gains from trade. The reason is opportunity cost. For example, we can plot the production of that one good against an aggregate measure of all other goods and services supplied in the economy. For example, a strike in one part of the factory can halt the whole production process. both parties gain as a result of fraudulent exchange. We tend to concentrate our labor on one primary activity. Second, what if we were to compare a small island economy to the United States? Relationship Between Specialization and Trade. Conversely, if there is a reduction in available resources (e.g., workers leave the country or a natural disaster strikes) the PPC would shift inwards. Many different commodities...were employed for this purpose. If I produce 1 more fish I must give up 1.5 coconuts (my opportunity cost). Under this regime, each worker becomes an expert in one isolated area of production, thus increasing his efficiency. Given that we satisfy our assumptions and are operating somewhere on our production possibilities curve, where on the curve should we be? Who should specialize in what? The first resources transferred from clothing to food production will likely be those that are best suited for food production. Comparing absolute advantage for two countries requires the additional assumption that the resources available to each country are identical. We can illustrate the gains from specialization and trade that arise from differences in comparative advantage using production possibilities curve. For example, increasing food production from 0 units to 10 units requires only a small reduction in clothing production. We can easily use the production possibilities curves of two countries to identify which has absolute and/or comparative advantage. We specialize. Higher output: the total output of goods and services will increase and the quality of goods and services produced will increase. While this assumption is made as a convenient simplification, it is not necessarily unrealistic. The relationship between specialization and comparative advantage is mainly due to the fact that specialization could be the natural consequence of an identified comparative advantage. It creates the possibility of increased unemployment among the labour force of the country. This effect is caused because once the jobs are broken down into the simplest possible jobs, it becomes much more, apparent to find methods or invent machinery that will save time or increase quality and accuracy of that work. E1-E2. Unfortunately, many poor nations don't have the luxury of making this choice. The greatest improvement in the productive powers of labor..seem to have been the effects of the division of labor. Money is a common medium of exchange and represents general purchasing power. If I specialize in teaching economics I would starve unless I was able to exchange the service I provide for food produced by someone else who specializes in farming. This may have a negative effect on the labour force and labour relations and eventually the productivity of the workers. The fact that labourers do not have to switch tasks during the say further saves time and money. For example, Maldives specialises in tourism and fishing products, Sri Lanka and India specialises in the production of tea. 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. First, which island has absolute advantage tells us nothing about the economic incentives to specialize. But this represents the undesirable situation of an underutilization of resources. 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. Absolute advantage may give bragging rights but that's all. The answer is that the price will fall somewhere between my oportunity cost and your opportunity cost. What is Specialization 4. For example, if the tradeoff considered is between making automobile engines versus motorcycle engines, the resources employed may be equally suitable in the production of either good. In one hour you can cut down 14 coconuts or catch 7 fish. Production Possibilities for Island Economy, Table 2-3. Adam Smith recognized that the increased productivity of labour after division happens due to the following reasons. As we noted above if resources are not fully utilized we are operating inside the PPC. Specialization and trade is called a positive sum game because we both are better off after exchange than we were before. If we both spend all our time catching fish, I can catch 8 fish in one hour while you catch 7 fish. Although division of labour can lead to considerable gains in the productivity and quality of production, division of labour can also have negative effects on the production for the following reasons. We can illustrate this problem with a PPC. Ofcourse, this exactly allowed Victorian factories (UK) to grow throughout the nineteenth century and develop themselves and their country simultaneously. Dependency on the whole labour force is increased with very high level of division of labour. Let's start with the situation where we are not specializing or trading. This can lead to increase speed and accuracy and skill in the narrow range of tasks he perform. 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