1. Specialization and Exchange
Overheads

2. Specialization and exchange
Specialization - A method of production in which each agent (firm) concentrates on a limited number of activities
Exchange - The act of trading with others to obtain what we desire

3. 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

4. Examples
Steak and eggs
Beef and laying hens
Medical care and automobile care
Hair styling and plumbing

5. WHY? Principle of specialization and exchange
Specialization and exchange enable us to enjoy
greater production and higher living standards
than would otherwise be possible
WHY?
As a result, all economies have been characterized
by high degrees of specialization and exchange

6. 3 reasons specialization pays
Why specialization and exchange make us better off
3 reasons specialization pays
1. Time to learn & acquire skills / learning by doing
Finish carpenter
X- ray technician
Electrical engineer
MIS consultant

7. 2. Set-up and switching time
Triplets in the copy shop
Fire brigade
Ice cream sundaes
Wooden pallet construction

8. Adam Smith and Pins

9. 3. Comparative advantage

10. Why specialization and exchange make us better off
1. Time to learn & acquire skills / learning by doing
2. Set-up and switching time
3. Comparative advantage

11. What is comparative advantage?
Comparative advantage is the ability to
produce a good or service at a
lower opportunity cost than other producers

12. What should he do? The track coach’s dilemma
Two runners (A & W) are projected to place 1-2
in 400 meter hurdles, and 2-5 in the 400 meter dash
Scoring is as follows:
Place Points
Only one of the runners can run each race
What should he do?

13. Figure it out A will be 1st in hurdles, 2nd in dash
W will be 2nd in hurdles, 5th in dash
Hurdles Place Points Dash Place Points Total Points
A W 1 7 4 3 10
W A 1 7 2 5 12
Place Points

14. 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 cost
than other producers.

15. The Flintstone Economy
Output per hour
Turnips
Mastodons 20 1
Fred
Wilma 80 2

16. This data is output per unit of input data
Turnips or mastodons per hour
Cars per day
Tons per acre
Shirts per hour
Returns per dollar invested

17. Who has the advantage in what?
Wilma has an absolute advantage in turnip gathering and in mastodon hunting
Wilma is more efficient at both activities!!

18. Comparative Advantage is Measured
in Terms of Opportunity Cost
The opportunity cost of any choice
is what we give up when we make
that choice

19. What does Fred give up to get a mastodon?
Wilma
Fred
Turnips
Mastodons 20 1 80 2
Output per hour
Fred gives up 20 turnips to get one mastodon
1 mastodon costs 20 turnips

20. Opportunity Cost of:
1 Turnip
1 Mastodon
20 turnips
Fred
Wilma

21. Pricing in the Flintstone economy
with turnips as the unit of exchange
Individual Opportunity Cost
Fred 1 mastodon costs 20 turnips
20 / 1 = 20
If Fred could pick up 40 ants per hour then
Fred 1 ant costs 1/2 turnip
20 /40 = 1/2

22. Wilma gives up 40 turnips per mastodon
What about Wilma?
Wilma
Fred
Turnips
Mastodons 20 1 80 2
Output per hour
Wilma gives up 40 turnips per mastodon
80 / 2 = 40
1 mastodon costs 40 turnips

23. Opportunity Cost of: 1 Turnip 1 Mastodon Fred Wilma 20 turnips

24. Who has the lowest opportunity cost for mastodons?
Wilma
Fred
Turnips
Mastodons
20 t
40 t
Fred has a comparative advantage in mastodon hunting!

25. Pricing in the Flintstone economy
with turnips as the unit of exchange
Fred 1 mastodon costs 20 turnips
Individual Opportunity Cost
Wilma
1 mastodon costs 40 turnips
Fred gives up less turnips for a mastodon
Fred has a comparative advantage in mastodon hunting!

26. The good that is the unit of comparison (or exchange) (or account)
in an economy is called the
numeraire good
The numeraire good is used as a way of
measuring the opportunity cost of other goods,
or how many units of the numeriare must be
given up
for one unit of a given good

27. In our example so far, turnips were the unit of exchange or numeraire
Wilma
Fred
Turnips
Mastodons
20 t
40 t
Now make mastodons the unit of exchange

28. What does Fred give up to get a turnip?
Wilma
Fred
Turnips
Mastodons 20 1 80 2
Output per hour
Fred gives up 1/20 of a mastodon per turnip
1 turnip costs 1/20 of a mastodon

29. Opportunity Cost of: 1 Turnip 1 Mastodon Fred Wilma 1/20 mastodon
20 turnips
Fred
Wilma
40 turnips

30. Wilma gives up 1/40 mastodon per turnip
What about Wilma?
Wilma
Fred
Turnips
Mastodons 20 1 80 2
Wilma gives up 1/40 mastodon per turnip
2 / 80 = 1/40
1 turnip costs 1/40 of a mastodon

31. Opportunity Cost of: 1 Turnip 1 Mastodon Fred Wilma 1/20 mastodon
20 turnips
Fred
Wilma
1/40 mastodon
40 turnips

32. Who has the lowest opportunity cost for turnips?
Wilma
Fred
Turnips
Mastodons
1/20 m
1/40 m
Wilma has a comparative advantage in turnip digging!

33. Pricing in the Flintstone economy
with mastodons as the unit of exchange (numeraire)
Individual Opportunity Cost
Fred 1 turnip costs 1/20 of a mastodon
Wilma 1 turnip costs 1/40 of a mastodon
Wilma gives up less mastodons for a turnip
Wilma has a comparative advantage in turnip digging!

34. How to determine who has the comparative advantage in what
1. Determine the output per period of each agent
2. Make an opportunity cost table (agents by goods)
3. For each good (column) choose a unit of exchange
4. Determine the opportunity cost of each good in terms
of the unit of exchange by dividing the production of
the unit of exchange by the production of the other good
5. The person with the lower opportunity cost has a comparative advantage in the production of each good

35. Example Computation 5 20 8 24 4 c 1/4 f 3 c 1/3 f Friday Crusoe Fish
Cassava 5 20 8 24
Friday
Crusoe
Fish
Cassava
4 c
1/4 f
3 c
1/3 f
Cassava is unit of exchange for fish
Fish is unit of exchange for cassava
4. Fill in comparative advantage table (unit of exchange per unit of good)
5. Friday has the comparative advantage in fish production
5a. Crusoe has the comparative advantage in cassava production

36. What is comparative advantage?
Comparative advantage is the ability
to produce a good or service
at a lower opportunity cost
than other producers

37. Utilizing comparative advantage
leads to more total output

38. Output before specialization
Hours Digging Turnips Hours Hunting Mastodons
Fred
Wilma
Total
Output after specialization
Hours Digging Turnips Hours Hunting Mastodons
Fred
Wilma
Total

39. according to their comparative advantage.
Total production of every good and service
will be greatest
when individuals specialize
according to their comparative advantage.

40. 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?

41. 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

42. Three methods of resource allocation
Tradition
Command
Market

43. 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.

44. Prices are a signal
for resource allocation

45. 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 buy
more 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.

46. Example Gas-powered model airplanes Patent on nerve gas antidote
Terrorists start setting off nerve gas
Income of patent owner
He likes to fly model airplanes
Production of airplanes

47. Three systems of resource ownership
Communism -
resources owned in common
Socialism -
resources owned by the state
Capitalism -
resources owned privately

48. Types of Economic Systems
Resource Allocation
Market
Command
Centrally
Planned
Capitalism
Private
Market
Capitalism
Resource
Ownership
Centrally
Planned
Socialism
Market
Socialism
State

49. The End