Question

1. Economists have emphasized beginning with Adam Smith in 1776, that specialization and division of labor benefit all participants due to the greater productivity in the manufacture of desired goods than when each attempts to satisfy his own wants through self-sufficient production. Explain the logic of division of labor in doing so in terms of absolute and comparative advantage.

Answer 1

The division of labor is extremely important for the efficiency of production. Comparative advantage refers to a situation when the opportunity cost of producing a particular good is lower for one producer than the other. Let us see an example:

Let there be two firms A and B, who use labor to produce two goods X and Y. The maximum amount of the two goods that can be produced ina day when labor is used for the production of one good only is:

A: X = 20, Y = 60

B: X =8 , Y = 16

Now, country A has an absolute advantage (higher production of a good given the resources) in both X and Y.

The opportunity cost of X for A = 60/20 = 3 units of Y

The opportunity cost of Y for A = 20/60 = 1/3 units of X

The opportunity cost of X for B = 16/8 = 2 units of Y

The opportunity cost of Y for B = 8/16= 1/2 units of X

Now, since the opportunity cost X is lower in B, B has a comparative advantage in X

Now, since the opportunity cost Y is lower in A, A has a comparative advantage in Y

Thus, for maximum efficiency, producer A should specialize in the production of Y and Producer B should specialize in the production of X.