ECON 3601 Lecture Notes - Lecture 7: Infant Industry Argument, International Trade, Imperfect Competition
28 Jun 2018
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Lecture 7 – External Economies of Scale and the International Location of Production
Introduction
• The models of comparative advantage thus far assumed constant returns to scale:
– When inputs to an industry increase at a certain rate, output increases at the same rate.
– If inputs were doubled, output would double aswell.
• But there may be increasing returns to scale or economies of scale:
– This means that when inputs to an industry increase at a certain rate, output increases at a faster
rate.
– A larger scale is more efficient: the cost per unit of output falls as a firm or industry increases
output.
• Mutually beneficial trade can arise as a result of economies of scale.
• International trade permits each country to produce a limited range of goods without sacrificing
variety in consumption.
• With trade, a country can take advantage of economies of scale to produce more efficiently
than if it tried to produce everything for itself.
Economies of Scale and Market Structure
• Economies of scale could mean either that larger firms or a larger industry would be more
efficient.
• External economies of scale occur when cost per unit of output depends on the size of the
industry.
• Internal economies of scale occur when the cost per unit of output depends on the size of a
firm.
Both external and internal economies of scale are important causes of international trade.
• They have different implications for the structure of industries:
– An industry where economies of scale are purely external will typically consist of many small
firms and be perfectly competitive.
– Internal economies of scale result when large firms have a cost advantage over small firms,
causing the industry to become imperfectly competitive.
Theory of External Economies
1. Specialized equipment or services may be needed for the industry, but are only supplied by
other firms if the industry is large and concentrated.
– For example, Silicon Valley in California has a large concentration of silicon chip companies,
which are serviced by companies that make special machines for manufacturing silicon chips.
– These machines are cheaper and more easily available there than elsewhere.
2. Labor pooling: a large and concentrated industry may attract a pool of workers, reducing
employee search and hiring costs for each firm.
3. Knowledge spillovers: workers from different firms may more easily share ideas that benefit
each firm when a large and concentrated industry exists.
• Represent external economies simply by assuming that the larger the industry, the lower the
industry’s costs.
• There is a forward-falling supply curve: the larger the industry’s output, the lower the price at
which firms are willing to sell.
• Without international trade, the unusual slope of the supply curve doesn’t matter much.
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Document Summary
Lecture 7 external economies of scale and the international location of production. Introduction: the models of comparative advantage thus far assumed constant returns to scale: When inputs to an industry increase at a certain rate, output increases at the same rate. If inputs were doubled, output would double aswell: but there may be increasing returns to scale or economies of scale: This means that when inputs to an industry increase at a certain rate, output increases at a faster rate. Both external and internal economies of scale are important causes of international trade: they have different implications for the structure of industries: An industry where economies of scale are purely external will typically consist of many small firms and be perfectly competitive. Internal economies of scale result when large firms have a cost advantage over small firms, causing the industry to become imperfectly competitive.
