Production Possibilities

Specialization and Trade's Impacts on PPF

Specialization and trade allow an economy to consume more of a specific good than it can produce.
Specialization and trade happens when two parties produce two goods. An example of specialization and trade is an isolated island occupied by two individuals, Lamont and Jerry. Lamont and Jerry both want to consume fish and bananas and are capable of producing both of them. As long as Jerry and Lamont are not aware of each other, each of them can continue to produce both goods and exist independently. As a result, without trade, both Jerry and Lamont have to produce and consume at a point on their respective production possibility frontiers.
A comparison of Jerry's frontier (top) and Lamont's frontier (bottom). Lamont is less successful than Jerry overall, as can be seen by his PPF lying to the left of Jerry's. For example, if Lamont gathers 15 bananas, he can only catch 1 fish, but Jerry can catch 10 fish when he gathers 15 bananas.
However, Lamont's PPF shows he is better at gathering bananas than he is at catching fish because his maximum number of bananas is greater than his maximum number of fish. Lamont has a comparative advantage in gathering bananas. Comparative advantage is the ability to produce a good or service at lower opportunity cost than another person or group.

When Jerry and Lamont finally meet, they consider the advantages of trade. According to their respective production possibility frontiers, Jerry can produce a higher total amount of either fish or bananas than Lamont can. Absolute advantage is the ability of one country, group, or individual to engage in a specific economic activity more efficiently than another. Jerry has an absolute advantage over Lamont in both goods. A common mistake when investigating trade is to look at absolute numbers in output and decide it is not worth trading. However, it must also be considered that although Jerry can gather bananas, he is more skilled and thus more efficient at catching fish. Catching fish is a better use of Jerry's scarce time and effort, because now he can rely on Lamont to gather bananas. It is a similar decision for Lamont. He does not have to spend any time trying to catch fish. He can let Jerry catch fish, and Lamont can do what he is better at, which is gathering bananas.

If they each do this, they can benefit from specialization and trade with each other. When they focus their efforts on what they do best (according to their comparative advantage), each of them will spend his time where he is most efficient.

The gains from specialization and trade come from opening up a new set of consumption combinations for each of them. Before trade, Jerry and Lamont could only consume what they could produce for themselves. The points on their respective possibility production frontiers were also maximum consumption points for each of them. However, with trade, both can now consume at a level they could not produce for themselves. Even though they can only maximize their production by producing at a point on their frontier, they can consume at a point outside of their production frontier only if they specialize and trade.
Jerry is producing only fish, the good in which he has comparative advantage and Lamont is producing only bananas, the good in which he has comparative advantage. Notice that both Jerry and Lamont are now consuming outside of their frontier. By specializing, that is producing the good for which they have a comparative advantage, they can consume more of both goods than they could when they were producing for their own consumption.