Which of the following goods or services would be most likely to be subject to (1) external economies of scale and (2) dynamic increasing returns? Explain your answers.a. Software tech-support servicesb. Production of asphalt or concretec. Motion picturesd. Cancer researche. Timber harvesting
7. Recently, a growing labor shortage has been causing Chinese wages to rise. If thistrend continues, what would you expect to see happen to external economy industriescurrently dominated by China? Consider, in particular, the situation illustrated inFigure 7-4. How would change take place?
External Economies of Scale and the International Location of Production In Chapter 3 we pointed out that there are two reasons why countries specialize and trade. First, countries differ either in their resources or in their technology and specialize in the things they do relatively well; second, economies of scale (or increasing returns) make it advantageous for each country to specialize in the production of only a limited range of goods and services. The past four chapters considered models in which all trade is based on comparative advantage; that is, differences between countries are the only reason for trade. This chapter introduces the role of economies of scale. The analysis of trade based on economies of scale presents certain problems that we have avoided so far. Up to now we have assumed that markets are perfectly competitive, so that all monopoly profits are always competed away. When there are increasing returns, however, large firms may have an advantage over small ones, so that markets tend to be dominated by one firm (monopoly) or, more often, by a few firms (oligopoly). If this happens, our analysis of trade has to take into account the effects of imperfect competition. However, economies of scale need not lead to imperfect competition if they take the form of external economies, which apply at the level of the industry rather than at the level of the individual firm. In this chapter we will focus on the role of such external economies of scale in trade, reserving the discussion of internal economies for the next chapter. LEARNING GOALS After reading this chapter, you will be able to: • Recognize why international trade often occurs from increasing returns to scale. • Understand the differences between internal and external economies of scale. • Discuss the sources of external economies. • Discuss the roles of external economies and knowledge spillovers in shaping comparative advantage and international trade patterns.