Specialisation and the division of labour

In order to solve the economic problem, markets employ a key process enabling them to allocate resources efficiently - that of specialisation.

In order to produce efficiently factors of production need to be combined in an efficient way, and be provided with an incentive to encourage efficiency. Factor incomes provide the key incentive in a market economy - these are wages, rents, interest and profits. Factor owners act in their own self-interest in order to derive this reward.

To make profits the entrepreneur must combine the other factors in an efficient way. In terms of using scarce resources, it is most efficient for factors to specialise in producing perhaps just one element in the production process. When applied to labour, specialisation is best achieved through a division of labour where large scale tasks are broken down into smaller ones so that individuals can become specialist at just one or a few tasks. Over time, factors can become more specialised. This is the essence of a market economy. Specialisation can be applied not only to factors of production, but also to firms, regions of a country and whole nations. Indeed, as specialisation increases so does the need for exchange and trade. As Adam Smith, the founding father of economics, noted in the 18th Century, specialisation and the division of labour form the basis of the wealth of all nations. Smith also noted that free trade became essential if specialisation was to be successful. This meant that countries would need to trade freely to gain the benefits of specialisation. As an example, he famously referred to wine making in Scotland when he said