Specialization And Exchange

If we were forced to, most of us could become economically self-sufficient. We could stake out a plot of land, grow our own food, make our own clothing, and build our own homes. But in no society is there such extreme self-sufficiency. On the contrary, every economic system over the past 10,000 years has been characterized by two features: (1) specialization, in which each of us concentrates on a limited number of pro ductive activities, and (2) exchange, in which most of what we desire is obtained by trading with others, rather than producing for ourselves.

Specialization and exchange enable us to enjoy greater production, and higher living standards, than would otherwise be possible. As a result, all economies exhibit high degrees of specialization and exchange.

There are three reasons why specialization and exchange enable us to enjoy greater production. The first has to do with human capabilities: Each of us can learn only so much in a lifetime. By limiting ourselves to a narrow set of tasks—fixing plumbing, managing workers, writing music, or designing Web pages—we are each able to hone our skills and become experts at one or two things, instead of remaining amateurs at a lot of things. It is easy to see that an economy of experts will produce more than an economy of amateurs.

A second gain from specialization results from the time needed to switch from one activity to another. When people specialize, and thus spend more time doing one task, there is less unproductive "downtime" from switching activities.

Before considering the third gain from specialization, it is important to note that these first two gains—acquiring expertise and minimizing downtime—would occur even if all workers were identical. To see why, let's consider an extreme example. Suppose that three identical triplets—Sheri, Gerri, and Keri—decide to open up their own photocopy shop. They quickly discover that there are three primary tasks to be accomplished each day: making photocopies, dealing with customers, and servicing the machines.

Suppose first that the triplets decide not to specialize. Each time a customer walks in, one triplet will take the order, make the copies, collect the money, make the change, and give a receipt. In addition, each time a machine runs out of paper or ink, the triplet who is using the machine must remedy the problem. You can see that there will be a great deal of time spent going back and forth between the counter, the copy machines, and the supply room. Moreover, none of the triplets will become an expert at servicing the machines, dealing with customers, or making photocopies. As a result of the downtime between tasks and the lack of expertise, the triplets will not be able to make the maximum possible number of copies or handle the maximum possible number of customers each day.

Now, let's rearrange production to take advantage of specialization. We'll put Sheri at the counter, Gerri at the photocopy machine, and Keri keeping the machines in working order. Suddenly, all of that time spent going back and forth is now devoted to more productive tasks. Moreover, Sheri becomes an expert at working the cash register, since she does this all day long. Gerri becomes an expert at making copies, figuring out the quickest ways to select the proper settings, position originals, and turn pages. And Keri learns how to quickly diagnose and even anticipate problems with the machines. Each task is now performed by an expert. You can see that specialization increases the number of copies and customers that the triplets can handle each day, even though there is no difference in their basic abilities or talents.

Adam Smith first explained these gains from specialization in his book An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776. Smith explained how specialization within a pin factory dramatically increased the number of pins that could be produced there. In order to make a pin . . .

One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires three distinct operations; to put it on is a [separate] business, to

Exchange The act of trading with others to obtain what we desire.

Economics is a subject that has benefited from specialization and the division of labor. To get a feel for the many different subjects that economists investigate, take a look at the Journal of Economic Literature's classification system at http://www.econlit.org/elcasbk.htm.

whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands.

Smith went on to observe that 10 men, each working separately, might make 200 pins in a day, but through specialization, they were able to make 48,000! What is true for a pin factory or a photocopy shop can be generalized to the entire economy: Even when workers are identically suited to various tasks, total production will increase when workers specialize.

Of course, in the real world, workers are not identically suited to different kinds of work. Nor are all plots of land, all natural resources, or all types of capital equipment identically suited for different tasks. This observation brings us to the third source of gains from specialization.

Further Gains to Specialization: Comparative Advantage. Imagine a shipwreck in which there are only two survivors—let's call them Maryanne and Gilli-gan—who wash up on opposite shores of a deserted island. Initially they are unaware of each other, so each is forced to become completely self-sufficient.

On one side of the island, Maryanne finds that it takes her one hour to pick one quart of berries or to catch one fish, as shown in the first row of Table 1. On the other side of the island, Gilligan—who is less adept at both tasks—requires an hour and a half to pick a quart of berries and three hours to catch one fish, as listed in the second row of the table. Since both castaways would want some variety in their diets, we can assume that each would spend part of the day catching fish and part picking berries.

Suppose that, one day, Maryanne and Gilligan discover each other. After rejoicing at the prospect of human companionship, they decide to develop a system of production that will work to their mutual benefit. Let's rule out any gains from specialization that might arise from minimizing downtime or from becoming an expert, as occurred in the photocopy shop example. Will it still pay for these two to specialize? The answer is yes, as you will see after a small detour.

Absolute Advantage: A Detour. When Gilligan and Maryanne sit down to figure out who should do what, they might fall victim to a common mistake: basing their decision on absolute advantage. An individual has an absolute advantage in the production of some good when he or she can produce it using fewer resources than another individual can. On the island, the only resource being used is labor time, so the reasoning might go as follows: Maryanne can pick one quart of berries more quickly than Gilligan (see Table 1), so she has an absolute advantage in berry picking. It seems logical, then, that Maryanne should be the one to pick the berries.

But wait! Maryanne can also catch fish more quickly than Gilligan, so she has an absolute advantage in fishing as well. If absolute advantage is the criterion for

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