Specialisation

Have you ever wondered why we import and export so many products? Why can’t we just produce them all by ourselves? Reading this explanation you will find out why some countries specialise in the production of certain goods and some in others.

What is specialisation in economics?

Specialisation in economics is when a country focuses on the production of a narrow range of goods or services to increase its efficiency. Specialisation relates not only to countries but also to individuals and firms. However, in economics, it refers to countries as the main players.

In today’s international economy, countries import raw materials and energy, and therefore, they produce a variety of goods and services. Nevertheless, they typically specialise in the production of a few products they can produce more efficiently and import the rest.

Absolute advantage and specialisation

Absolute advantage is a country’s ability to produce more of a good or service than other countries from the same amount of resources. Alternatively, it is also when a country produces the same amount of a good or service with fewer resources.

Imagine there are only two countries in the global economy, Spain and Russia. Both countries produce apples and potatoes. Table 1 shows how many units can each country produce from one unit of resource (in this case it can be land, hummus, or weather conditions).

Table 1. Absolute advantage 1 - StudySmarter.

Spain can produce more apples than Russia whereas Russia can produce more potatoes than Spain. Thus, Spain has an absolute advantage over Russia when it comes to apple production, whereas Russia has an absolute advantage in the production of potatoes.

When both countries produce apples and potatoes from the same amount of the resource, the total amount of apples produced will be 5,000, and the total amount of potatoes will be 8,000. Table 2 shows what happens if they specialise in the production of a good they have an absolute advantage in.

Table 2. Absolute advantage 2 - StudySmarter.

When each country specialises, the total amount of units produced is 8,000 for apples and 12,000 for potatoes. Spain can produce 8,000 apples with all its resources whereas Russia can produce 6,000 potatoes with all its resources. In this example, specialisation allowed countries to produce 3,000 more apples and 4,000 more potatoes compared to the example without specialisation.

Comparative advantage and specialisation

Comparative advantage is a country’s ability to produce a good or service at a lower opportunity cost than other countries. Opportunity cost is a potential benefit that was missed when choosing an alternative option.

Let’s use the previous example. However, now we will change the possible number of units each country can produce so that Spain has an absolute advantage for both apples and potatoes (see table 3).

Table 3. Comparative advantage 1 - StudySmarter.

Although Spain has an absolute advantage in the production of both apples and potatoes, the country has a comparative advantage in apple production. This is because we measure the comparative advantage in terms of what is given up when an output of a product is increased by one unit. Spain has to give up 4,000 apples in order to increase the production of potatoes by 2,000 whereas Russia has to give up only 1,000 apples to produce 1,000 potatoes. If one country has an absolute advantage in both goods or services, it has to produce the one its absolute advantage is greater for, i.e. the one it has a comparative advantage for. Therefore, Russia has a comparative advantage in the production of potatoes.

Table 4. Comparative advantage 2 - StudySmarter

With a complete specialisation, apple production increased to 8,000 whereas potato production decreased to 2,000. However, the total output has increased by 2,000.

Production possibility frontier (PPF) diagram

We can illustrate the comparative advantage on the PPF diagram. Values in the figure below are presented in 1,000 units.

Fig. 1 - PPF comparative advantage

Spain has an absolute advantage regarding both apples and potatoes. However, the country has a comparative advantage in the production of apples only, and Russia has a comparative advantage in the production of potatoes.

This is because:

- For Spain 4,000 apples = 2,000 potatoes (2 apples = 1 potato)

- For Russia 1,000 apples = 1,000 potatoes (1 apple = 1 potato).

This means that Spain needs twice the amount of the resource to produce the same quantity of potatoes than to produce the same quantity of apples, whereas Russia needs the same amount of the resource to produce the same amount of potatoes and apples.

Heckscher-Ohlin theory and specialisation

The Heckscher-Ohlin theory is a theory of comparative advantage in the international economy. It states that the difference in costs of production between countries is related to the relative amounts of factors of production such as capital, labour, and land.

You must note that specialisation is not a way to maximise output. In fact, specialisation can either increase or decrease the output. Let’s have a look at the example of Spain and Russia producing apples and potatoes. However, we will change the possible number of units each country can produce.

Table 5. Specialisation and maximisation of output 1 - StudySmarter.

If Spain and Russia fully specialise in products they have a comparative advantage in, the total output of apples will decrease by 1,000 whereas the output of potatoes will increase by 2,000. Unfortunately, the complete specialisation resulted in a fall in the production of apples. This is typical for the complete specialisation according to the principle of comparative advantage when one country has an absolute advantage in the production of both goods or services.

Table 6. Specialisation and maximisation of output 2 - StudySmarter.

For this reason, this is very unlikely for countries to fully specialise. Instead, they combine the production of both goods by reallocating some resources. This way they maximise their output.