what is the relationship between production, specialization and exchange

Archaeological Papers of … You should recognize that this is not a model of economic growth. Money can be used to buy any goods and services offered for sale. Relationship Between Specialization and Trade. We both have an incentive to specialize and trade. The answer is that the price will fall somewhere between my oportunity cost and your opportunity cost. Of course the role of money is much more extensive than this, but we will save that for a later chapter. One country can not have comparative advantage in both goods. Adam Smith also emphasized incentives for technological advancement. Money is a common medium of exchange and represents general purchasing power. It may be easier to demonstrate by slightly changing the example. The article is organized as follows: Section 2 presents stylized facts of African international trade and defines a specialization rule. 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. And let's think about her opportunity cost for producing a plate. Why are there increasing opportunity costs? Our second assumption requires the full and efficient use of all available resources. Does that mean I should do both? 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. Absolute Advantage. a curve that does not shift. Relationship Between Specialization and Trade. You can then see that Country A has the flattest slope and the lowest opportunity cost and comparative advantage. In the figure below we can see that the PPC falls below the subsistence level. Workers become very skillful and effective int their single allocated task. Explain the relationship between Diminshing Returns (or increasing Marginal Cost) and the Supply Curve. 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. 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. Increasing opportunity costs is a reflection of the specialized characteristics of resources. If we both spend all our time catching fish, I can catch 8 fish in one hour while you catch 7 fish. Now that we have established that there is an incentive to specialize and trade the question becomes what will the terms of exchange be? Example, the specialisation of teachers in different subjects in CHSE. No exchange can...be made between them. of coffee in exchange for 3.5 lb. ... the factors of production should aim … Comparing absolute advantage for two countries requires the additional assumption that the resources available to each country are identical. 12. There are other aggregated combinations that reveal interesting tradeoffs such as all consumer goods versus all capital goods. Generally we assume an increase in available resources raises the production capacity of both goods. John M. Berry, Washington Post (Washington, DC: April 17, 1999) pp. Similarly, if resources are not efficiently used we could increase output of one good without sacrificing output of the other good. 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. An assembly line, where individual workers perform specific tasks in the production process, is the best example of specialization. At What Point on the PPC Should We Operate. Humanitarian aid would be required. 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. Declining industries means some must lose their jobs. Recall that the combination of limited resources and unlimited wants implies scarcity. 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. Individuals seek those jobs they are capable of performing and that pay the highest wage or salary. A major drawback of division of labour is, boredom and alienation, which people may experience when carrying out very simple repetitive tasks. 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. Finally, there is regional and local specialization. Consider the example of trade in two goods, shoes and refrigerators, between the United States and Mexico. An improvement in technology, however, may be specific to one product. The exchange price should fall between 0.5 fish (your opportunity cost) and 0.67 fish (my opportunity cost). E1-E2. If the PPCs were bowed outwards then we would have the situation of increasing opportunity costs. Moreover, the concept of division of labour or specialization is mainly useful in mass production and assembly lines. When we specialize and exchange we both benefit. Poor countries with a hungry population may be unable to pay that cost and may be forever locked into poverty. 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. 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. Another reason is that, time is saved by eliminating the constant need to move from one operation to the next by the worker. 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. Would you be willing to give me 3 coconuts? of nuts Tom: 3 lb. The country that has the lowest opportunity cost for producing coconuts is the one with the flattest curve -- Country B. Finally increasing from 40 to 50 requires the largest sacrifice. These resource factors include: The availability of natural resources is of course a major determinant of comparative advantage. of coffee and 4.5 lbs of nuts They are both better off, compared with the no specialization and no trade situation!! comparative advantage, and not the simpler concept of absolute advantage? There are several reasons. Competition will help to keep the prices lower in the economy. What is Specialization 4. Comparative advantage is the driving force of specialization and trade. In this situation the PPC shifts outward only along one axis (Figure 2-4). 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. Of course there are many thousands of goods and services that are supplied in any economy. Assume the country produces only two goods: consumption goods and capital goods. The first resources transferred from clothing to food production will likely be those that are best suited for food production. Artificial barriers to trade (e.g., import tariffs). There are two key terms used to describe the differences in production capabilities of two individuals: absolute advantage and comparative advantage. When specialization occurs it is when one person does one aspect of a job and voluntary exchange is when buyers and sellers engage in market transactions. In a graph of the PPC the opportunity cost of the good represented on the horizontal axis is measured as the slope on the PPC. A scarce resource used to satisfy one need means there is some other need that cannot be satisfied. But how do we really know what paid labor to specialize in? No, because I would be giving up more (1.5 coconuts) than I would get from you (1 coconut). Underutilization of Resources, Figure 2-3. 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. In one hour I can cut down 12 coconuts or catch 8 fish. 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. For example, we start with a simple application of the concept of opportunity cost when considering government policy decisions on import quotas or tariffs. 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. 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 act in our rational self-interest by seeking out those activities that minimize our opportunity costs (or equivalently, maximize net benefit). A higher output with lower prices will mean more wants will be satisfied with the given amount of scarce resources. 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. 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. We specialize. This is specialisation at national level. 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. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). As country B increases production of coconuts it sacrifices the smaller volume of fish production. Adam Smith was one of the first economists to explicitly identify the productive benefits of specialization, which he referred to as the "division of labor.". To cutting down coconuts and 3.5 fish below and/or to the exchange price of fish must lie between... Capacity of both goods developed economies, specialization, and capital ) are fixed money is common! Plants and, in turn, may be unable to pay that cost comparative... At everything does n't mean I should do everything are dedicated to the left the... 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