Advantages of specialization and exchange

1. Advantages of specialization and exchange Specialization and exchange enable us to achieve achieve a standard of living that would be impossible without it.

2. Advantages of specialization • Human capabilities are limited—that is, there is not enough time for one individual to master plumbing, auto mechanics, tax accounting, computer programming, . . . • Switching from one task to another involves “downtime.” • Not all resources are equally suited to different kinds of productive activity—this is the principle of comparative advantage.

3. Castaway economics Notice that Maryanne has he absolute advantage in both berries and fish, since she is able to pick a quart of berries and catch one fish is less time than it takes Gilligan

4. Now you might think that I since I have an absolute advantage over Gilligan there would be no advantage to specialization. But it is comparative advantage that really counts.

5. A person has a comparative advantage in producing some good if he or she can produce it with smaller opportunity cost than some other person can. Opportunity Cost of:

6. To pick 1 quart of berries, Maryanne must allocate the time necessary to catch 1 fish. But for Gilligan, the opportunity cost of picking a quart of berries is just ½ of a fish. Therefore, Gilligan has the comparative advantage in berries.

7. I have the comparative advantage in fishing, since I have to give up 1 quart of berries to get 1 fish and Gilligan must give up 2 quarts per fish.

8. Gains from specialization and exchange What happens when Gilligan catches one fewer fish? Fish  1  Berries  2 What sacrifice is made when Maryanne catches one more fish? Fish  1  Berries  1

9. What happens when Gilligan and Maryanne move toward production along lines of comparative advantage? • Maryanne makes up for the fish that Gilligan is no longer catching. • Gilligan more than makes up for the berries that Maryanne is no longer picking.

10. Systems of resource allocation • Economists identify three methods of determining what gets produced, how it gets produced, and who gets what: • Traditional economy • Command or centrally planned economy • Market economy What? How? For Whom?

11. Traditional economy • Resources are allocated according to long-established practices. • Methods of production tend to be unchanging. • Goods and services are distributed based on community views about fairness and justice.

12. Command or centrally planned economy • Resources are allocated according to explicit instructions issued by central planning authorities. • Gosplan of the old U.S.S.R. is the classic example of a central planning agency.

13. Market economy • Resources are allocated though individual decision making. • The market system relies on the choices made by individuals (buyers and sellers) to allocate resources in a socially optimal way. • The economy is an agglomeration of markets, defined as “groups of buyers and sellers with the potential to trade with each other.” • Income distribution is mainly determined by the market value of resources owned (including labor).