SPECIALIZATION AND TRADE

SLIDE 2

What happens to an economy as it grows? Roles become

specialized in nature. Why roles become specialized in nature is
because people have something called a comparative advantage
in the creation of a particular good or service. A person has a
comparative advantage in an activity if that person can perform
the activity at a lower opportunity cost than anyone else.

A similar concept is that of an absolute advantage. A person has

an absolute advantage if that person is simply more productive
than others.

Absolute advantage involves comparing productivities while

comparative advantage involves comparing opportunity costs.

It is very important to note that a person can have absolute

advantage in all activities. But a person cannot have a
comparative advantage in all activities because of opportunity
cost. It is the opportunity costs comparison that matters.
 If you have the comparative advantage in a particular good or
service, you should specialize in the production of that good or
service. If you absolutely outproduce anyone else in a particular
good or service, you are characterized as having the absolute
advantage, but you may not have the comparative advantage in
that good or service.

To help better understand the concept, imagine a country that

has an absolute advantage in producing every good and service
that exists. That country should not necessarily produce every
good and service just because they can outproduce everyone
else. That country should focus on producing what it has a
comparative advantage in.

SLIDE 3

As an example, consider the things that need doing around my

house … we have dishes to wash and video games to play. My
favorite game being the Legend of Zelda.

In an hour, Corey can wash 30 dishes or complete 30 tasks in

Zelda.
 Corey's opportunity cost of washing 1 dish is 1 task in Zelda
(OCCDish = 1 Zelda).
Corey's opportunity cost of producing 1 task in Zelda is 1 dish
(OCCZelda = 1 Dish).
Suppose that I need to do my chores in equal number (50/50
split – this was all my wife’s idea), so I do 15 tasks in Zelda and
wash 15 dishes per hour.

SLIDE 4

The other individual in my household is my wife, Mona. In an

hour, Mona can complete 6 tasks in Zelda or wash 30 dishes.
Mona's opportunity cost of washing 1 dish is then 1/5 of a task
in Zelda (OCMDish = 1/5 Zelda).
Mona's opportunity cost of completing 1 task in Zelda
is 5 dishes (OCMZelda = 5 Dishes).
Suppose that Mona spends 10 minutes washing dishes
and 50 minutes playing Zelda, so that she completes 5 tasks in
Zelda and washes 5 dishes an hour.

SLIDE 5
 So, who has the absolute advantage? Remember, when one
person is more productive than another person in several or even
all activities they have the absolute advantage.

Corey is three times as productive as Mona—Corey can

complete 15 tasks in Zelda and wash 15 dishes an hour and
Mona can only complete only 5 tasks in Zelda and wash 5 dishes
an hour.

But, who has the comparative advantage in playing Zelda? For

this, we have to compare the opportunity costs.

Corey’s opportunity cost of a task in Zelda is 1 dish.

Mona’s opportunity cost of a task in Zelda is 5 dishes.

It is clear that Corey’s opportunity cost of a task in Zelda is less

than Mona’s, so Corey has a comparative advantage in
producing tasks in Zelda.

SLIDE 6

Who has the comparative advantage in washing dishes?

 Mona’s opportunity cost of washing a dish is 1/5 of a task in
Zelda.
Corey’s opportunity cost of washing a dish is 1 task in Zelda.

Mona’s opportunity cost of washing a dish is less than Corey’s,

so Mona has a comparative advantage in washing dishes.

Now, I’m an economist and my wife is not … so I explain that

we take advantage of “specialization.” I propose the following
deal to achieve some gains from trade:
Corey and Mona should produce more of the good in which they
have a comparative advantage: in fact, they should completely
specialize!

SLIDE 7

Corey will produce 30 tasks in Zelda and wash 0 dishes per

hour.
Mona will wash 30 dishes per hour and produce 0 tasks in
Zelda.

SLIDE 8
 Corey and Mona then trade:
Corey sells Mona 10 tasks in Zelda and buys 20 washed dishes.
Mona sells Corey 20 washed dishes and buys 10 tasks in Zelda.

SLIDE 9

After trade:

Corey has 20 tasks in Zelda and 20 clean dishes.

Mona has 10 tasks in Zelda and 10 clean dishes.
Corey gains 5 tasks in Zelda and 5 clean dishes an hour —
remember, I originally produced only 15 tasks in Zelda
and 15 clean dishes.
Mona gains 5 tasks in Zelda and 5 clean dishes an hour —
remembering she originally produced 5 tasks in Zelda
and 55 clean dishes.

SLIDE 10

Let’s look at the gains from trade graphically.

Mona initially produces at point A on her PPF.

 Corey initially produces at point A on his PPF.

Mona’s opportunity cost of producing a clean dish is less than

Corey’s.

So Mona has a comparative advantage in producing clean

dishes.

Corey’s opportunity cost of producing a task in Zelda is less

than Mona’s.

So Corey has a comparative advantage in producing tasks in

Zelda.

SLIDE 11

If Mona specializes in producing clean dishes, she

produces 30 clean dishes an hour at point B on her PPF.
If Corey specializes and produces 30 tasks in Zelda (and 0 clean
dishes an hour), he produces at point B on his PPF.

SLIDE 12

Mona and I exchange clean dishes for Zelda tasks along the red
“Trade line.” The price of a clean dish is 2 Zelda tasks or the
price of a Zelda task is 1/2 of a clean dish (see the previous
tables to confirm this).

Mona buys Zelda tasks from Corey and moves to point C — a

point outside her PPF. In other words, she has gained from this
trade!

Corey buys clean dishes from Mona and moves to point C —

also, a point outside his PPF. In other words, he has gained from
this trade!

In real life I proposed this trade to my wife — namely, that I

specialize in playing Legend of Zelda and that she specialize in
washing the dishes (our respective comparative advantages).
Now, as a non-economist she did not see the efficiency benefits
and refused the trade vigorously.

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