specialization and exchange overheads. specialization specialization - a method of production in...
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SpecializationSpecialization - A method of production in which each agent (firm) concentrates on a limited number of activities
Specialization and exchangeSpecialization and exchange
ExchangeExchange - The act of trading with others to obtain what we desire
Specialization and Exchange
There are gains to specializing in a small number of tasks
and trading the products we produce as compared to
doing it all ourselves
Steak and eggs
Examples
Beef and laying hens
Medical care and automobile care
Hair styling and plumbing
Principle of specialization and exchange
Specialization and exchange enable us to enjoygreater production and higher living standardsthan would otherwise be possible
As a result, all economies have been characterizedby high degrees of specialization and exchange
WHY?
Why specialization and exchange make us better off
1. Time to learn & acquire skills / learning by doing
3 reasons specialization pays
Finish carpenter
X- ray technician
Electrical engineer
MIS consultant
2. Set-up and switching time
Triplets in the copy shop
Fire brigade
Ice cream sundaes
Wooden pallet construction
1. Time to learn & acquire skills / learning by doing
2. Set-up and switching time
3. Comparative advantage
Why specialization and exchange make us better off
What is comparative advantage?
Comparative advantage is the ability toproduce a good or service at alower opportunity cost than other producers
The track coach’s dilemma
Two runners (A & W) are projected to place 1-2in 400 meter hurdles, and 2-5 in the 400 meter dash
Scoring is as follows:Place Points 1 7 2 5 3 4 4 3 5 2 6 1
Only one of the runners can run each race
What should he do?
Hurdles Place Points Dash Place Points Total Points
A W
Figure it out
W A
Place Points 1 7 2 5 3 4 4 3 5 2
A will be 1st in hurdles, 2nd in dash
W will be 2nd in hurdles, 5th in dash
1 7 4 3 10
1 7 2 5 12
Absolute versus comparative advantage
An individual producer has an absolute advantage in the production of a product if he has the ability to produce the good or service using
fewer resources than other producers use.
An individual producer has a comparative advantage in the production of a product if she has the ability to produce the good or service at a
lower opportunity costthan other producers.
This data is output per unit of input data
Tons per acre
Cars per day
Shirts per hour
Returns per dollar invested
Turnips or mastodons per hour
Who has the advantage in what?
Wilma has an absolute advantage inturnip gathering and in mastodon hunting
Wilma is more efficient at both activities!!
Comparative Advantage is Measuredin TermsTerms of Opportunity Cost
The The opportunity costopportunity cost of any choice of any choice
is is what we give upwhat we give up when we make when we make
that choicethat choice
What does Fred give up to get a mastodon?What does Fred give up to get a mastodon?
Fred gives up 20 turnips to get one mastodonFred gives up 20 turnips to get one mastodon
1 mastodon costs 20 turnips1 mastodon costs 20 turnips
Wilma
Fred
Turnips Mastodons
20 1
80 2Output per hour
Pricing in the Flintstone economywith turnips as the unit of exchange
Fred 1 mastodon costs 20 turnips
Individual Opportunity Cost
If Fred could pick up 40 ants per hour then
20 / 1 = 20
20 /40 = 1/2
Fred 1 ant costs 1/2 turnip
What about Wilma?What about Wilma?
Wilma gives up 40 turnips per mastodonWilma gives up 40 turnips per mastodon
1 mastodon costs 40 turnips1 mastodon costs 40 turnips
80 / 2 = 4080 / 2 = 40
Wilma
Fred
Turnips Mastodons
20 1
80 2Output per hour
Who has the lowest opportunity cost for mastodons?
20 t
40 tWilma
Fred
Turnips Mastodons
Fred has a comparative advantage in mastodon hunting!
Pricing in the Flintstone economywith turnips as the unit of exchange
Fred 1 mastodon costs 20 turnips
Individual Opportunity Cost
Wilma
Fred has a comparative advantage in mastodon hunting!
1 mastodon costs 40 turnips
Fred gives up less turnips for a mastodon
The good that is the unit of comparison
The numerairenumeraire good is used as a way ofmeasuring the opportunity costopportunity cost of other goods,
in an economy is called thenumerairenumeraire good
(or exchange)(or exchange) (or account)(or account)
or how many units of the numeriarenumeriare must begiven up
for one unit of a given good
In our example so far, turnips were theunit of exchange or numeraire
Wilma
Fred
Turnips Mastodons
20 t
40 t
Now make mastodons the unit of exchange
What does Fred give up to get a turnip?What does Fred give up to get a turnip?
Fred gives up 1/20 of a mastodon per turnipFred gives up 1/20 of a mastodon per turnip
1 turnip costs 1/20 of a mastodon1 turnip costs 1/20 of a mastodon
Wilma
Fred
Turnips Mastodons
20 1
80 2Output per hour
What about Wilma?What about Wilma?
Wilma gives up 1/40 mastodon per turnipWilma gives up 1/40 mastodon per turnip
Wilma
Fred
Turnips Mastodons
20 1
80 2
2 / 80 = 1/402 / 80 = 1/40
1 turnip costs 1/40 of a mastodon1 turnip costs 1/40 of a mastodon
Wilma
Fred
1 Turnip 1 Mastodon
1/20 mastodon 20 turnips
40 turnips
Opportunity Cost of:
1/40 mastodon
Who has the lowest opportunity cost for turnips?
Wilma has a comparative advantage in turnip digging!
20 t
40 tWilma
Fred
Turnips Mastodons
1/20 m
1/40 m
Pricing in the Flintstone economywith mastodons as the unit of exchange (numeraire)
Fred 1 turnip costs 1/20 of a mastodon
Individual Opportunity Cost
Wilma 1 turnip costs 1/40 of a mastodon
Wilma has a comparative advantage in turnip digging!
Wilma gives up less mastodons for a turnip
How to determine who has the comparative advantage in what
2. Make an opportunity cost table (agents by goods)
1. Determine the output per period of each agent
5. The person with the lower opportunity cost has a comparative advantage in the production of each good
3. For each good (column) choose a unit of exchange
4. Determine the opportunity cost of each good in termsof the unit of exchange by dividing the production ofthe unit of exchange by the production of the other good
Example Computation
3. Cassava is unit of exchange for fish Fish is unit of exchange for cassava
5. Friday has the comparative advantage in fish production
5a. Crusoe has the comparative advantage in cassava production
4. Fill in comparative advantage table (unit of exchange per unit of good)
Friday
Crusoe
Fish Cassava
5 20
8 24 Friday
Crusoe
Fish Cassava
4 c
3 c
1/4 f
1/3 f
What is comparative advantage?
Comparative advantage is the abilityto produce a good or serviceat a lower opportunity costthan other producers
Output before specialization
Hours Digging Turnips Hours Hunting MastodonsFred 6 120 2 2Wilma 6 480 2 4Total 12 600 4 6
Output after specialization
Hours Digging Turnips Hours Hunting MastodonsFred 0 0 8 8Wilma 8 640 0 0Total 8 640 8 8
Total production of every good and service
will be greatest
when individuals specialize
according to their comparative advantage.
The three problems of resource allocation
1. Which goods and services should be produced with society’s resources?
2. How should the goods and services be produced?
3. Who should get these goods and services?
Resource allocation is ...
the method used to determine
which goods and services will be produced,
how they will be produced,
and who will get them
What is a price?
The price of a product is the amount of money that must be paid to a seller
to obtain a good or service.
How prices lead to changes in resource allocation
An increase is the desire for product will cause consumers to bid up the price of the product.
A higher price for a product will encourage sellers to produce (obtain) and then sell more of the product.
To produce more of the product, sellers will buymore of the resources needed to produce it.
The owners of these resources will have a higher income.
The owners of these resources will now have more influence on what is produced.
ExampleExample
Gas-powered model airplanesGas-powered model airplanes
Patent on nerve gas antidotePatent on nerve gas antidote
Terrorists start setting off nerve gasTerrorists start setting off nerve gas
Income of patent ownerIncome of patent owner
Production of airplanesProduction of airplanes
He likes to fly model airplanesHe likes to fly model airplanes
Three systems of resource ownership
Communism - resources owned in common
Socialism - resources owned by the state
resources owned privatelyCapitalism -
Types of Economic Systems
MarketCapitalism
MarketSocialism
CentrallyPlannedCapitalism
CentrallyPlannedSocialism
ResourceOwnership
Resource Allocation
Private
State
Market Command