We study a general equilibrium model with specialization and division of labor. The market coordinates all individual's decisions in choosing their patterns of specialization in order to utilize positive network effects of division of labor net of transaction costs. We establish the equilibrium existence theorem, the first and second welfare theorems, and the core equivalence for a family of general equilibrium models with both possible increasing returns and transaction costs. Using an analytical framework with consumer-producers, economies of specialization, and transaction costs, we resurrect the spirit of the classical economics of the division of labor in a modern body of mathematical formalism. © 2004 Elsevier Inc. All rights reserved.