7c The Gains from Specialization and Exchange
One approach to illustrating the advantages of specialization in production and exchange is to
use wage data. This is simply another way of getting the main point across that people gain from
specializing and exchanging. If students get the comparative example from 7b, you may want to
stop there. Or, you may want to stick with this approach which avoids the ratios and uses simple
multiplication, addition and subtraction. The problem with this approach is that it is not likely to
get your students through any common exams.
[Optional explanation of the gains from specialization and exchange.
Let’s put some numbers on this so we can see the gains from specialization and exchange.
Assume that a cabinetmaker is very good at making cabinets and specializes in doing that. She
allocates about two hours of her human capital to making a cabinet. Assume further that she
averages about $50 per hour making and selling her cabinets. She owns a nice home and has
lawns that have to be mowed and leaves and other debris that have to be raked. It would take her
about two hours to do the yard work.
There is a teenage girl down the street who is very good at mowing lawns and raking yards and
she specializes in doing that. She allocates about three hours of her human capital to doing a fair
sized yard and she charges $10 per hour. She would like a cabinet for her bedroom and could
make it herself. It would take her about 20 hours of human capital.
The cabinetmaker is better both at making cabinets and mowing and raking than is the teenager.
If the cabinetmaker is better at both activities, is there any way that both the cabinetmaker and
the teacher could benefit from specialization and exchange? Should the economics teacher hire
the teenager to mow and rake, to make cabinets, both, neither?
The question can be answered by answering another question. Even though the cabinetmaker is
better at both activities, is she “more better” at one activity than another? Does she have a
comparative advantage in one activity? And does the teenager have a comparative advantage in
one activity?
Cabinetmaker
Teenager
Cabinetmaker
advantage over
teenager
Teenager disadvantage
Hours to
Make
Cabinet
3
20
Hours to
Mow and
Rake Yard
2
3
3/20 = .15
2/3 = .67
20/3 = 6.67
3/2 = 1.5
Yes, they do. The cabinetmaker can make a cabinet in 15% of the human capital it takes the
teenager to make a cabinet and she can do the yard work with 67% of the human capital it takes
the teenager. Her advantage is greater in making cabinets than in doing yard work. She should
specialize in cabinets and hire the teenager to do her yard work. She has a greater (or
comparative) advantage in cabinets as opposed to yard work. She is “more better” in
cabinetmaking than in yard work.
But won’t the teenager get ripped off? Well, no actually. The teenager has a smaller
disadvantage in yard work (1.5) compared to cabinetmaking (6.67), and so economists say that
she has a comparative advantage in yard work. In comparing yard work to cabinetmaking, her
disadvantage is smallest in yard work. When discussing comparative advantage, it is important to
realize that the comparison is not between the two workers, but between the two activities.
Compared to cabinetmaking, the teenager is “less ungood” in yard work. While the language is
certainly inelegant, the point is, hopefully, clear.
Let’s see who gains when both parties specialize. The table below will help illustrate the
situation. This table is based on the assumptions that the cabinetmaker earns $50 per hour and
the teenager earns $10 per hour.
Cabinetmaker
Time to make cabinet
Hourly pay
Cost to make cabinet
Cost to buy cabinet
Saving by buying cabinet
Time to do yard work
Hourly pay
Cost to do yard work
Cost to buy yard work
Saving by buying yard
work
Teenager
20 hours
$10
$200
$150
$50
2 hours
$50
$100
$30
$70
Who gains what depends upon the opportunity cost of both individuals. It will cost the
cabinetmaker two hours of human capital to mow and rake the lawn. The opportunity cost of
using her human capital to do yard work is valued at $100 since she could be using her human
capital in those two hours to be making a cabinet. If she hires the teenager, it will cost $30. It is
in her best interest to specialize in making cabinets. She is ahead by $70. The teenager could
build her own cabinet, but that would take 20 hours of human capital, which is valued at $200. If
she buys the cabinet, it will cost $150. It is in the cabinetmaker’s best interest to specialize in
cabinets and the teenager’s to specialize in mowing and raking. Even though the cabinetmaker is
better at both making cabinets and mowing and raking, because the two have different
opportunity costs, it benefits both parties to specialize and exchange. In an exchange between
two parties, even if one party is better at both activities, both parties can benefit from
specialization and exchange. That is the law of comparative advantage.]
In an efficient economy, people become teachers, plumbers, carpenters, engineers or nurses if
they have a comparative advantage in that field. The more this rule is followed, the greater the
efficiency of the economy and the more goods and services society will produce from its scarce
resources