STOCHASTIC DEMAND, SPECIALIZATION, AND INCREASING RETURNS

Adam Smith pointed out that specialization makes individuals more productive through improved dexterity, judgment, and innovation. The theory of increasing returns incorporated in this paper does not depend on the presence of such intra-personal enhancement of productivity. Instead, we note that specialization reduces the costs of meeting stochastic demand that is infrequent and probabilistically uncertain. Specialization characterized as coordinating convention clarifies and extends the economic logic in Smith's interpretation of conditions required for economic progress.