Poor countries with a hungry population may be unable to pay that cost and may be forever locked into poverty. Key Concepts: Benefits of Trade, Trade, Exchange and Interdependence 45 mins 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). Declining industries means some must lose their jobs. It is most often applied to systems of mass-production and is one of the basic organizing principles of the assembly lines. We can illustrate the gains from specialization and trade that arise from differences in comparative advantage using production possibilities curve. The first resources transferred from clothing to food production will likely be those that are best suited for food production. Competition will help to keep the prices lower in the economy. The PPC represents all possible combinations of two goods or services that can be produced given available resources and technology. We do not need to assume the countries are the same size to determine who has comparative advantage using the PPC model. This is because the workers who specialize in a single task have a lot of time and occasion to practice their allotted job. A major drawback of division of labour is, boredom and alienation, which people may experience when carrying out very simple repetitive tasks. This increases the productivity (output per worker per hour) as well as quality of work done by a worker. Second, what if we were to compare a small island economy to the United States? If there is an increase in the resources available (e.g., an increase in the size of the labor force) we can produce more. The concepts of comparative and absolute advantage also apply to macroeconomic aggregates such as regions or nations. Higher output: the total output of goods and services will increase and the quality of goods and services produced will increase. 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. 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. 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. If I can produce a good or service at a lower opportunity cost than you then I have a comparative advantage. In our simple economy the price will be some number of coconuts. 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). A bigger market: specialisation and international trade increases the size of the market, offering opportunities for large-scale of production for a larger market. 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. Some automation (use of specialised machinery) may arise from the division of the general manufacturing process into small, separate and simple tasks. Assume the country produces only two goods: consumption goods and capital goods. In option A all available resources are dedicated to the production of clothing. Then we apply the basic production possibilities curve to the unfortunate dilemma facing poor countries in their ability to feed their people. No. I get 6 coconuts and 4 fish and you get 7 coconuts and 3.5 fish. But why is specialization efficient? 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. In Rethinking Craft Specialization in Complex Societies: Archaeological Analyses of the Social Meaning of Production, edited by Z. Hruby and R. Flad. The opportunity cost of each coconut is 2/3 fish. Higher output: the total output of goods and services will increase and the quality of goods and services produced will increase. When we specialize we tend to concentrate our labor on one primary activity. Production and Consumption on Island, Table 2-2. 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. Production Possibilities for Island Economy, Table 2-3. Because goods and services are produced from scarce resources, goods and services are also scarce. If the majority of consumers prefer corn products to wheat products, then the economy should probably produce more corn than wheat. The questions and problems we face are seldom the same. 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. 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. Artificial barriers to trade (e.g., import tariffs). Scarcity requires choice and implies costs. 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. Greenspan did not mention any specific industries or products. With barter no money is used. Workers become very skillful and effective int their single allocated task. Underutilization of Resources, Figure 2-3. Comparing absolute advantage for two countries requires the additional assumption that the resources available to each country are identical. What is Division of Labour 3. The specialisation of Thoddoo island for watermelons and Dhiggaru island for rihaakuru is an example of regional specialisation. Interrelated with it, particularly in modern developed economies, is specialization of machines. Similarly, if resources are not efficiently used we could increase output of one good without sacrificing output of the other good. The opportunity cost of producing more food increases as we move to the right in the graph. If there is an improvement in technology we can also produce more or everything. On the flip side, the opportunity cost for me to catch 8 fish is that I forego cutting down 12 coconuts. According to Adam Smith, “Wealth of nations”, the economic growth(ie. In some of the examples and sample problems in this chapter we assume the PPC is a straight line. Thus the price of fish must lie somewhere between 1.5 and 2 coconuts. You and I are stranded on a tropical island. 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. 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). A futher increase from 10 to 20 requires a larger sacrifice. Specialisation also means that the resources are being distributed among small and competing uses at a particular industry or a nation. 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. 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. Of course the role of money is much more extensive than this, but we will save that for a later chapter. of coffee in exchange for 3.5 lb. Specialization and trade is called a positive sum game because we both are better off after exchange than we were before. Adam Smith recognized that the increased productivity of labour after division happens due to the following reasons. There are other aggregated combinations that reveal interesting tradeoffs such as all consumer goods versus all capital goods. Again we ask, what do we do? The application of the model with respect to opportunity cost and comparative advantage requires that we are operating at some point on the PPC. As we noted above if resources are not fully utilized we are operating inside the PPC. As more resources are transferred those resources are progressively less well suited to food production. a curve that does not shift. 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. An improvement in technology, however, may be specific to one product. More ebooks have been added to the ebooks section. I should specialize in fish and you should specialize in coconuts. 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. This, in turn, may lead to the general workforce acquiring narrow skills. First let's calculate what the opportunity cost is for each of our production options. The PPC for the United States would dwarf that of the island economy. Workers in a factory who are responsible for only one part of the process become as skilled as they possibly can in that process without the distraction of learning other skills in the other areas. 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. Hence increasing the production process into a great extent. There are several problems with barter: The introduction of money reduced the difficulty or costs of barter. But he pointed to anti-dumping complaints and the imposition of so-called countervailing duties on imports as examples of anti-competitive actions. This may have a negative effect on the labour force and labour relations and eventually the productivity of the workers. 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). 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. This implies the opportunity costs are constant at all points on the curves. But a country can also pursue comparative advantage despite a lack of natural resources. 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. It may be easier to demonstrate by slightly changing the example. voluntary exchange negates the need for specialization. In this chapter we will use the principle of opportunity cost to justify the incentive individuals have to specialize in their labor. Relationship Between Specialization and Trade. ... the factors of production should aim … You and I are stranded on a tropical island. An assembly line, where individual workers perform specific tasks in the production process, is the best example of specialization. Specialization is related to another economic concept, division of labor, discussed at great length by Adam Smith, the 18th-century … Explain the relationship between Diminshing Returns (or increasing Marginal Cost) and the Supply Curve. In this situation the PPC shifts outward only along one axis (Figure 2-4). The opportunity cost of each fish is 3/2 coconuts. In this situation absolute advantage has no meaning. For me to produce one more fish you must be willing to give me at least 1.5 coconuts. For example, it is no longer necessary to have a coincidence if wants. 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. Now that we have established that there is an incentive to specialize and trade the question becomes what will the terms of exchange be? Specialisation at individual level involves giving workers individual jobs so that the worker’s capacity to one task in particular will increase. What "price" should I charge for the fish I produce? One political response as mentioned is to protect the jobs. 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. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). 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