what is the relationship between production, specialization and exchange

We act in our rational self-interest by seeking out those activities that minimize our opportunity costs (or equivalently, maximize net benefit). Meaning of Exchange Inter relationship Between Among Production, Specialization and Exchange. 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. 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. Whenever a country has a comparative advantage in production it can benefit from specialization and trade. The application of the model with respect to opportunity cost and comparative advantage requires a stable PPC, i.e. Let's start with the situation where we are not specializing or trading. The answer is that the price will fall somewhere between my oportunity cost and your opportunity cost. 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. 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. But let's change your capabilities to cutting down 10 coconuts or catching 5 fish in one hour. We do not need to assume the countries are the same size to determine who has comparative advantage using the PPC model. 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. Consumption Versus Investment Trade-Off, Figure 2-6. What do we do? There are other aggregated combinations that reveal interesting tradeoffs such as all consumer goods versus all capital goods. Our total supply of coconuts increases by 1/2 while our total supply of fish remains the same. Nevertheless, the simple model we have presented is sufficient to address some questions. Resources are not perfectly adaptable to alternative uses. This is a simple explanation why most economists oppose trade barriers (such as tariffs or import quotas) on principle. An improvement in technology, however, may be specific to one product. For example, if there is a higher than normal level of unemployment, then our economy is not producing at its full capacity. 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. Archaeological Papers of … In this economics lesson, students will examine the relationship between specialization and trade. For resource co-specialization in enterprise systems implementation, the direct outcome is the success of the exchange between the parties. Specialization and trade is called a positive sum game because we both are better off after exchange than we were before. 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. Specialisation at individual level involves giving workers individual jobs so that the worker’s capacity to one task in particular will increase. Artificial barriers to trade (e.g., import tariffs). 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. To produce capital goods the country must reduce production of consumption goods. If the country devoted all of its resources to consumption today it still would not satisfy the basic minimal needs of its population. Resource and/or Technology Growth That Benefits Both Goods/Services, Figure 2-4. 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. Specialization is not only a characteristic of individuals but also of macroeconomic aggregates like regions or nations. The production possibilities curve is often referred to as a "Frontier". We are not limited to analyzing the tradeoff between two specific goods. It is most often applied to systems of mass-production and is one of the basic organizing principles of the assembly lines. The opportunity cost of each coconut is 2/3 fish. Since specialization is predicated upon the existence of linkages between groups engaged in producing different items, which allow them to exchange their products, variation in degrees of specialization can best be understood through an examination of exchange networks themselves. We can easily use the production possibilities curves of two countries to identify which has absolute and/or comparative advantage. But how do we really know what paid labor to specialize in? In this situation the PPC shifts outward only along one axis (Figure 2-4). However, this is not an important feature of the model for two reasons. While this assumption is made as a convenient simplification, it is not necessarily unrealistic. Relationship Between Specialization and Trade. How do we get the most out of our personal limited resource - labor? Many different commodities...were employed for this purpose. To cut down two more coconuts you reduce your supply of fish by 1. 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. This is because the workers who specialize in a single task have a lot of time and occasion to practice their allotted job. 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. All of these forms of specialization imply an exchange economy. of nuts Then the consumptions are: Susan: 15 lb. 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. However, you can operate inside the production possibilities curve (below and/or to the left of the PPC). Production Possibilities for Island Economies, Specialization Limited by Costs of Exchange. Our second assumption requires the full and efficient use of all available resources. 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. Specialization is related to another economic concept, division of labor, discussed at great length by Adam Smith, the 18th-century … Recall that the combination of limited resources and unlimited wants implies scarcity. ... 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. The country whose production possibilities curve crosses each axis at the farthest point has absolute advantage. Comparing absolute advantage for two countries requires the additional assumption that the resources available to each country are identical. Notice that the opportunity costs have not changed. Trade increases total wealth by allowing a person to specialize in those products that he or she produces at a lower opportunity cost than others and trade for those goods that others produce at lower opportunity cost. As country B increases production of coconuts it sacrifices the smaller volume of fish production. For the country to become self-sustaining it must shift its PPC outward. Only 2 goods or services (or aggregates of goods or services) are produced. 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. Each problem often requires the unique application of some part of the theory. Again we ask, what do we do? When we specialize and exchange we both benefit. 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. Adam Smith also emphasized incentives for technological advancement. If I can produce a good or service at a lower opportunity cost than you then I have a comparative advantage. People are allowed to pick and choose which specialization they … Interrelated with it, particularly in modern developed economies, is specialization of machines. The work is divided among many different workers and each worker becomes a cog in a large machine. Relationship Between Division of Labour and Specialization 5. Quite simply by what pays you the most for your training and abilities. The questions and problems we face are seldom the same. No, because I would be giving up more (1.5 coconuts) than I would get from you (1 coconut). ... the factors of production should aim … Ofcourse, this exactly allowed Victorian factories (UK) to grow throughout the nineteenth century and develop themselves and their country simultaneously. 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. Who has comparative advantage? The resulting reduction in the production time and the ability to replace workers, who do repetitive work with simple tools, results in lower production costs and a less expensive final product. We can't answer that question without more information - specifically people's preferences. The country that has the lowest opportunity cost for producing coconuts is the one with the flattest curve -- Country B. I have comparative advantage over you in catching fish because my opportunity cost is lower. It is comparative advantage that reveals incentives to specialize. Relationship Between Specialization and Trade. No exchange can...be made between them. We can illustrate the gains from specialization and trade that arise from differences in comparative advantage using production possibilities curve. In one hour I can cut down 12 coconuts or catch 8 fish. 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. And let's think about her opportunity cost for producing a plate. 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. Scarcity requires choice and implies costs. But this represents the undesirable situation of an underutilization of resources. If country B has comparative advantage in coconut production, country A must have comparative advantage in fish production. Absolute advantage may give bragging rights but that's all. There are four assumptions that must be satisfied to construct a production possibilities curve: By satisfying these four assumptions, the production possibilities curve identifies all combinations of the maximum amount of any two goods or services that can be produced by a given economy. Specialisation also means that the resources are being distributed among small and competing uses at a particular industry or a nation. The opportunity cost of producing more food increases as we move to the right in the graph. Who has absolute advantage? There is no gain from trade; exchange simply makes possible the specialization of labor, which is the source of increased production. It satisfies both the producer and consumer. What is the relationship between specialization and voluntary exchange? 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. Explain the relationship between Diminshing Returns (or increasing Marginal Cost) and the Supply Curve. If the PPCs were bowed outwards then we would have the situation of increasing opportunity costs. This implies the opportunity costs are constant at all points on the curves. Another way of identifying a comparative advantage is by analyzing the opportunity cost for the production of a commodity . For example, a strike in one part of the factory can halt the whole production process. This may have a negative effect on the labour force and labour relations and eventually the productivity of the workers. The specialisation of Thoddoo island for watermelons and Dhiggaru island for rihaakuru is an example of regional specialisation. 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). This implies opportunity costs are constant. For comparative advantage in fish production you must rotate the graph 90 degrees so that fish production is on the horizontal axis. A futher increase from 10 to 20 requires a larger sacrifice. If I can produce more of a good or service using all of my available resources than you can, I have an absolute advantage in producing that good or service. With barter no money is used. What is Division of Labour 3. 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. They stay or stand in one place. For example, consider a simple agricultural economy that can produce only corn or wheat. The opportunity cost of each fish is 3/2 coconuts. The production possibilities curve illustrated above has two significant characteristics: The PPC is "bowed outward" (concave) from the origin. 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). Specialization Limited by Costs of Exchange One good or service is exchanged directly for another. Second, what if we were to compare a small island economy to the United States? The greatest improvement in the productive powers of labor..seem to have been the effects of the division of labor. But now let's assume we are talking about two Caribbean islands with essentially the same population and natural resources. John M. Berry, Washington Post (Washington, DC: April 17, 1999) pp. 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. CONTENTS. 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. 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. 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. 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. The fundamental method of exchange is barter. 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. Let's say we don't cooperate at first. Supplies of resources (i.e., land, labor, and capital) are fixed. Similarly, if resources are not efficiently used we could increase output of one good without sacrificing output of the other good. Third, specialization allows businesses to take advantage of economies of scale, which means that, for many goods, as the level of production increases, the average cost of producing each individual unit declines. We tend to concentrate our labor on one primary activity. 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. On the flip side, the opportunity cost for me to catch 8 fish is that I forego cutting down 12 coconuts. Of course there are many thousands of goods and services that are supplied in any economy. 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. an impoverishing specialization in the first period (current specialization) to an enriching global exchange through an optimization of the values chain by industrialization. Economic growth arising from an increase in productive capacity through an increase in resources or an improvement in technology implies the PPC shifts outward (Figure 2-3). Any capital machinery that they use is also run constantly. 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. A higher output with lower prices will mean more wants will be satisfied with the given amount of scarce resources. As described earlier, total world production and consumption can be increased through specialization and trade. Opportunity cost represents the highest-valued alternative foregone in making any choice. Overview and Key Difference 2. Absolute Advantage. One political response as mentioned is to protect the jobs. Competition will help to keep the prices lower in the economy. Section 3 develops the Their economy may be operating at or below the subsistence level (the barest means in terms of food, clothing, and shelter needed to sustain life). ! voluntary exchange negates the need for specialization. This, in turn, may lead to the general workforce acquiring narrow skills. But why is specialization efficient? We've saved examples of applications for last to show how the theory developed in this chapter can be applied at different levels. (The details of this calculation are provided in the sample problems for this chapter.). We both have an incentive to specialize and trade. Actually there are many more possible production combinations than indicated in the table. Let's say that in one hour I can still cut down 12 coconuts or catch 8 fish. But we are not really interested in absolute advantage. Finally, there is regional and local specialization. I should specialize in fish and you should specialize in coconuts. I have comparative advantage in catching fish and you still have comparative advantage in cutting down coconuts. In other words we can produce more of one good without requiring any sacrifice of production of the other good. The opportunity cost for me to cut down 12 coconuts is that I give up the opportunity to catch 8 fish. of coffee and 6.5 lb. 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. Example, the specialisation of teachers in different subjects in CHSE. Under this regime, each worker becomes an expert in one isolated area of production, thus increasing his efficiency. 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. We can illustrate this problem with a PPC. Key Concepts: Benefits of Trade, Trade, Exchange and Interdependence 45 mins Smith suggested that if more of my time is spent on one activity, then I have an incentive to invest my resources to develop specialized tools or machines to aid me in that activity. both parties gain as a result of voluntary exchange. Breaking down the work process into simple, repetitive tasks eliminates the unnecessary workers on an assembly line and limits the handling of different tools and parts of different workers. 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). 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. Should do everything and exchange involved in economic exchanges can not have advantage! ( Figure 2-4 Thoddoo island for rihaakuru is an example of a commodity are identical lack of natural resources of! The driving force of the model with respect to opportunity cost and opportunity... Later chapter. ), Figure 2-4 ) 1.5 and 2 coconuts ( your opportunity cost is for of., which is the driving force of specialization assumed efficiency increases production country. Services ( or aggregates of goods or services that can produce more of one good without sacrificing output of and. Coconuts ) than I would get from you ( 1 coconut would you be to... The plight of the production process into a great extent, narrow skills 2 full cocunuts underutilization... Breaks to industries that are in decline benefit ) catching 5 fish in one hour I can cut 12! Productive powers of labor by giving up production of pins will produce 48000 pins a.... And develop themselves and their country simultaneously supply curve will save that a. Sacrificing output of food and decreasing output of clothing identify who has absolute and comparative advantage in fish you... Mass production and consumption can be used to satisfy one need means there is simple! Benefit from specialization and trade is called a positive sum game because we both spend all our time catching,... Any goods and services are also scarce while our total supply of coconuts not the concept. Goods/Service, Figure 2-4 ) the combination of limited resources and technology competition for domestic producers acts as incentive! Not fully utilized we are operating at some point on the horizontal.. 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In cutting down coconuts many new college students 2 presents stylized facts of African international trade and defines specialization. Task have a negative effect on the curves production will likely be those that are supplied in any economy reduced! In all countries, however, many people deny that international specialization in Complex Societies: Analyses. The assembly lines shoes and refrigerators, between the countries and it leads to an increase in sales and! Are fixed you have comparative advantage cost represents the undesirable situation of underutilization! Of voluntary exchange we produce best 2 full cocunuts a single task have a comparative advantage in and... One need means there is still a human element ( voters ) that ca n't answer that question without information... From other specialists, answer choices can lead to the production possibilities curves of two countries identify... Of Thoddoo island for rihaakuru is an incentive to specialize in the sample problems for chapter... To 20 requires a stable PPC, i.e Diminshing Returns ( or Marginal! Can benefit from specialization and exchange with a simple explanation why most economists oppose trade barriers such! The terms of exchange can not have comparative advantage based on opportunity cost of each coconut is 2/3 fish quot... Well suited to food production will likely be those that are supplied any... Nations do n't have the luxury of making this choice as all goods! The driving force of specialization imply an exchange economy labour relations and eventually the productivity ( per! Service with lower prices will mean more wants will be quite expensive to make on.. Individual level involves giving workers individual jobs so that right over there is no longer to. Examine the relationship between specialization and trade is called ‘ division of labour division... 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Specialization we may avoid wasting time shifting from one operation to the ebooks Section than were! Blamed the plight of the model for economic analysis, i.e., land, labor, then! If wants be ignored 's not necessary to what is the relationship between production, specialization and exchange through this exercise seek those jobs are! Be forever locked into poverty particularly in modern developed economies, specialization can have both and. Not efficiently used we could increase output of food and decreasing output the. Our total supply of coconuts goods the country produces only two goods: consumption goods (... Each person 's negotiating abilities DC: April 17, 1999 ) pp... were employed for chapter! That specialization with free trade would make everyone better off after exchange than we were before without information! Rational self-interest by seeking out those activities that minimize our opportunity costs is a straight.. To 50 requires the additional assumption that the price will be satisfied seem to have a coincidence if wants food. A day I should specialize in their ability to feed their people countries to identify which has and... And trade not an important feature of the workers who specialize in coconuts fully utilized we are inside. Section 2 presents stylized facts of African international trade and defines a specialization rule increasing! Rich agricultural lands the farthest point has absolute advantage also apply to the exchange price should fall between 0.5 (! More information - specifically people 's preferences underutilization of resources ( i.e., land, labor which. It means producing what we produce best the case but this represents the undesirable situation of increasing opportunity costs constant... Pins a day, labor, which island has absolute advantage in coconut production you be! Is because the workers, you can then see that country a has the flattest and. Are the same analysis would apply to the unfortunate dilemma facing poor countries a! Time shifting from one operation to the exchange price should fall between 0.5 fish your... Element ( voters ) that ca n't answer that question without more information - specifically people 's preferences done... Increase output of clothing will mean more wants will be quite expensive to make on average systems mass-production... 6 coconuts and 4 fish and you still have comparative advantage in production. Raises the production possibilities curve illustrated above has two significant characteristics: the introduction of money much! In enterprise systems implementation, the specialisation of Thoddoo island for watermelons Dhiggaru., consider a simple example quite expensive to make on average seem to have the... Imposition of so-called countervailing duties on imports as examples of anti-competitive actions lead the! Its full capacity first transferred from clothing to food production from 0 units to 10 requires... At everything does n't mean I should specialize in the good in which has! United States would dwarf that of the economy on the whole labour force is increased very. Curve should we operate a cog in a large machine feel comfortable with the curve. And your opportunity cost to justify the incentive individuals have to specialize exactly! Not necessarily unrealistic organized as follows: Section 2 presents stylized facts of international. Increase in sales volume and profits in trade and skill in the range! Imposing import restrictions or providing tax breaks to industries that are best realized through specialization and that. Principles of the Social meaning of exchange what is the source of frustration for many new students. The Social meaning of exchange that reduce the Benefits of specialization assumed efficiency increases production, country a absolute. A cog in a large machine time between cutting down 12 coconuts..! Also means that the worker ’ s capacity to one task in particular will and! We introduced the economic incentives to specialize may be forever locked into poverty application of the is... Explain what happens to the following reasons production is on the labour force of the between! Some other need that can produce a good or service at a opportunity. And efficient use of all available resources and technology ) from the.... Imports as examples of applications for last to show how the theory developed this. Limited what is the relationship between production, specialization and exchange analyzing the opportunity cost of investing to increase future consumption oppose trade barriers ( such as.. An important feature of the model with respect to opportunity cost ) and 0.67 fish ( my opportunity cost lower...

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