Specialisation, when one person is better at making one type of good than another.
The first example is comparative advantage. This is simply when the PPFs cross on a graph (refer to this post if you need more information) Take a simple example of carrots and peas produced by 2 people.
Carrots Peas
Pete 5 10
Katy 30 2
Made with one unit of natural resource
It is easy to see that Pete should specialise in peas and Katy should specialise in carrots. So instead of producing 10 peas with 1 unit of natural resource, Pete can produce 20 peas, an increase of 8 peas before specialisation. Similarly, Katy can now produce 60 carrots, an increase of 25 carrots before specialisation.
Since only one person has all the peas and one has all the carrots, an exchange rate must be formed between Pete and Katy. The minimum exchange rate for 1 pea of 0.5 a carrot and the maximum is 3 carrots. The Mutually beneficial rate of exchange is half way between these two value-1.75 carrots for 1 pea.
But when one person is better at producing both goods, it is known as absolute advantage. Katy, this may be useful to you!!
Using the same example as before...
Carrots Peas
Pete 10 5
Katy 15 30
Made with one unit of natural resource
This example shows that Katy is better at producing both goods. But since each has to specialise in one good, Katy should specialise in the good that she is best at, and Pete should specialise in the one he is 'least worst' at. So Katy specialises in peas, and Pete specialises in carrots.
To find out the Mutually benificial rate of exchange (MBEC)...
The maximum value of one carrot is 2 peas and the minimum value is 0.5 peas. So halfway between the two is 1.25 peas, the MBEC.
The gain from specialisation (GFS) is -5 carrots +25 peas. We know that 1 carrot is worth about 1.25 peas, so sub. this value in (time for some algebra...)
-5(1.25) peas +25 peas = +18.75 peas. A GFS is ALWAYS positive!!
