The happenings "inside" the Wisconsin State Treasury and across the street at the State Capitol

The Economy & You #36: Specialization and Comparative Advantage


In a previous article, I wrote about the concepts of scarcity and choice (CFE #33). The article stated that whether an economy is simple or complex, decisions must be made as to what is produced and how much. The concepts of specialization and comparative advantage can be a part of the decision making process.

The idea that a person and society as a whole benefits from specializing in what they do best has a long history and is an important tenet of economics.  The British economist David Ricardo theorized that specialization and free trade will benefit all trading parties. This theory of comparative advantage states that even those parties that have an absolute advantage in the production of goods and services can benefit from trade. 

PRODUCTION (by task)

 

Food

Wood

Allan

5

5

Betty

10

8

 

The classic illustration of this is the example of a two person economy (usually on a deserted island) where Allan and Betty are marooned. Allan and Betty have only two tasks to accomplish, gathering food to eat and cutting wood for the fire.  In this example, Betty is able to gather more food in one day (10 bushels) and cut more wood in one day (8 logs) than Allan.  In this example, Betty has an absolute advantage in gathering food or cutting wood. 

One could think that since Betty is better at everything that she should do all of the food gathering and wood cutting.  This is not right since Betty has only so many hours in the day. Even though Allan is slower at gathering food and cutting wood, there is still a way for Allan to contribute so that both he and Betty are better off.  Through specialization and trade, the division of work (gathering food and cutting wood) can be made so that both Allan and Betty will be better off even though Betty is absolutely better at everything than Allan.

PRODUCTION (separately)

 

PRODUCTION (specialization)

 

Food

Wood

   

Food

Wood

Allan

2.5

2.5

 

Allan

0

5

Betty

5

4

 

Betty

8

2.5

Total

7.5

6.5

 

Total

8

7.5

 In the example above, Betty can gather 10 bushels of food per day while Allan can only gather 5 bushels.  Also, Betty can cut 8 logs while Allan can cut 5 logs.  Betty has an absolute advantage in gathering food and cutting wood. Because time is limited, opportunity cost is created.  In this example, Allan has a comparative advantage in cutting wood in that Bill can cut wood at a lower opportunity cost than Betty. In this example, Allan’s opportunity cost is 1 log for 1 bushel of food, while Betty’s opportunity cost is 1 log for 1.25 bushels of food.

 If Allan and Betty complete tasks individually, they will produce 7.5 bushels of food and 6.5 logs of wood.  Yet, if Allan and Betty specialize in the tasks where they have a comparative advantage, they can produce 8 bushels of food and 7.5 logs of wood. Therefore, it would be best if Allan specializes in wood cutting and Betty specializes in food gathering. By doing so, Allan and Betty can increase their total production than if they performed these tasks individually.

USE (with trade)

 

Food

Wood

Allan

3

2.5

Betty

5

5

Total

8

7.5

 In addition, trade allows Allan and Betty to be better off.  Allan will trade some of his wood with Betty for food.  By trading, Allan will have .5 more bushels of food than if he had done the work by himself and Betty will have 1.0 more logs of wood.

 This example is the basic premise as to why most economists see the value of free trade.  Even if one country is better than another at producing all goods, there are advantages to both nations in specializing and trading.

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