INTERNATIONAL TRADE

International Trade



International Trade

Question a

Comparison of External Internal Economies Of Scale

Economies of scale refer to the reductions in cost that firms achieve by producing in larger rather than smaller volumes of output. “Economies” in the context refers to the benefits incurred by reducing costs, largely by spreading fixed costs over a greater quantity of output.

Mass production occurs through the standardization of parts and a detailed division of labor. Specialized divisions of labor, however, require a relatively large scale of output because a large pool of workers is generally necessary. Scale economies operate when increases in factor inputs generate disproportionately larger increases in output or, in more technical terms, the production function in not linear. For example, if a firm increases its inputs of labor and capital by 20% but sees its output rise by 30%, it enjoys economies of scale. Thus, they represent the opposite of diminishing returns in the production process.

Economies of scale tend to favor the formation of larger firms and hence relatively oligopolistic market structures (those dominated by a few giant companies). Large firms generally pay much less for material inputs than do small firms because they buy in bulk and often enjoy economies of scale in transportation as well as in the production process. The presence of economies of scale varies widely among firms and industries. It is indisputable in sectors such as industrial agriculture and capital-intensive forms of manufacturing, such as steel and automobiles. The degree to which services, with intangible outputs, enjoy economies of scale is less clear (Melitz, 2003, 93).External And Internal Economies Of Scale In Relation To Intra- Industry Trade (IIT)

Indeed, the choice of location cannot be considered in isolation from scale and production technique. Different scales of operation may require different locations to give access to markets of different sizes. Conversely, location itself can influence the combination of inputs and, hence, the technique adopted. Economies of scale tend to favor a select group of geographic locations over dispersed production patterns.

True long term economies of scale are rare, and probably do not exist. In a classic textbook example, “external” economies of scale are said to result from economies of scale internal to another industry (presumably short run). So the distinction rests on a difference in the period of adjustment between the buying and supplying industries. Learning effects are one of the most common long run source of decreasing unit costs, but as Norsworthy & Jang (pp.139-44) consider, learning effects are not properly classified as scale effects, because they are not reversed by declining output, even when inputs are fully adjusted. Communication protocols are part of the technology that supports network transactions.

To define systematically the various sources of economies of scale it is necessary to use an implicit model of production: a cost function, which is the most commonly applied empirical representation of the technology of production. The cost function is the preferred stochastic specification. Norsworthy & Jang and Norsworthy & Tsai consider the cost function in service industries and telecommunications ...