How does one increase productivity? Why do nations focus on producing certain goods over others and then trade? These questions are addressed in the discussion of specialization in economics.
Definition of Specialization
Specialization is when a nation or individual concentrates its productive efforts on producing a limited variety of goods. It oftentimes has to forgo producing other goods and relies on obtaining those other goods through trade.
Division of Labor
Adam Smith was one of the first economists to explain the benefits one gets from specialization. He focused on describing the benefits of individuals specializing in labor.
In An Inquiry into the Nature and Causes of the Wealth of Nations (1776), he describes the benefits of one type of specialization, division of labor, which is when cooperating individuals perform specialized tasks. Smith discusses this type of specialization in the context of a pin factory.Smith explains that if the pin factory had each person making pins from start to finish, they may be able to make upward of 20 pins each a day. Now, consider if the pin-making process was divided into distinct operations, and each person were able to specialize in a particular operation in the pin-making process.
He posits that an entire factory of 10 workers could produce 48,000 pins a day. With a factory of 10 workers, that would equate to 4,800 pins per person per day compared to the initial 20 pins per day without division of labor.Here is an example of specialization – the assembly line. Each person specializes in one distinct operational function, thus improving the efficiency of production overall. We see this type of production frequently at cafes, restaurants, etc.
Then, we realize that if I were to pick 5 more berries, it would cost me 1/5 fish. If you were to catch one more fish, it would cost you five berries, but we would both be better off.
Our total number of berries would remain the same, but we would gain 4/5 fish. We continue to shift our activity until we are each specializing in producing one good. This is the concept of specializing based on comparative advantage; you would spend all your time on catching fish and I would on picking berries.
The resulting quantities are shown here:
Our overall production increased from 82.5 fish and berries to 110 fish and berries when we specialized in producing the good we had the comparative advantage to produce.
Based on our opportunity costs, my value of one fish is 20 berries. In other words, I would be willing to give you up to 20 berries to get one fish. Your value of fish is five berries and would be willing to give me one fish for at least five berries.So, we would trade! The ‘price’ at which we would trade at would be somewhere between your opportunity cost (5 berries) and mine (20 berries).
Specialization in trade is when one person or nation concentrates their entire labor and resources on producing one good. It enables society to reach a higher point of productivity and is applicable at the micro- and macroeconomic levels.
Adam Smith first explained specialization through division of labor, which is when cooperating individuals perform specialized tasks. This can be seen on an assembly line.David Ricardo then applied the concept of specialization using opportunity cost to justify why nations are willing to specialize and enter into trade. Opportunity cost is the cost of the next best alternative, or what you are giving up to do what you are currently doing. Someone is said to have a comparative advantage in producing a good when he or she has the lowest opportunity cost to produce that good. This is not to be confused with absolute advantage.
Absolute advantage means you can produce a good with fewer resources than another person or nation.
After completing the lesson, you should make a point to:
- Define specialization as it relates to economics
- Explain the term ‘division of labor’
- Define ‘opportunity cost’
- Distinguish between a comparative advantage and an absolute advantage
- Discuss the advantages of specialization in economics