ECONOMIES OF SCALE,IMPERFECT COMPETITION AND TRADE CONSTANT RETURNS TO SCALE OR INCREASING RETURNS TO SCALE?

Increasing returns to scale- output grows proportionately more that the increase in inputs. They may occur because at a larger scale of operation a greater division of labor and specialization becomes possible; also, the introduction of specialized and productive machinery can be feasible as investment. Economies of scale( increasing returns to scale or internal economies)- refer to the reduction in the average costs of production as the firms output expands. External economies- refer to the reduction in each firms average costs of production as the entire industry output per time period expands ( for reasons external to the firm).

Linders hypothesis (1961) a nation exports those manufactured goods for which a large domestic market exists; acquires experience &efficiency in order to export goods to nations with similar tastes and income levels .
External economies (Ee) and specialization

As Ee depend on the expansion in the number of firms in the industry rather that on the size of each firm, they are consistent with perfect competition. Ee affect the pattern of IT( international Trade). The nation where a given industry is larger is likely to have lower average costs of production ( due to greater Ee) and to be the exporter of the good on international market. The nation in which an industry is first established or becomes larger may be a purely historical accident. Once an industry is etablished or has become larger in one nation than in another, the first nation is likely to gain an even bigger comparative advantage over the second nation in the long run. Its advantage becomes cumulative over the time. As firms gain experience, they make improvements in their product and their production techniques. As other firms can imitate the innovating firm, average cost of production fall for the entire industry. This decline in the average cost of production as the cumulative output of the industry increases and firms accumulate knowledge over time is called dynamic external economies.

Economies of scale result of specialization and division of labor and also Lower input costs- when a firm buys inputs in bulk, it can take advantage of volume discounts (commercial economies); Marketing economies made by spreading the high cost of advertising across a large level of output; Financial economies made by borrowing money at lower rates of interest than smaller firms; Specialised inputs: as the scale of production increases, the firm can employ the use of specialized labor and expensive machinery resulting in greater efficiency; Costly inputs such as research and development, managerial expertise are possible; External economies of scale can also be realized from the above-mentioned sources as a result of the companys geographical location ( lower transportation costs, development of support industries, technology and managerial expertise shared)

Is bigger really better?

Diseconomies of scale- an economic concept referring to a situation in which economies of scale no longer function for a firm; rather than experiencing continued decreasing costs per increase in output, firm see an increase in marginal cost when output is increased. Internal diseconomies of scale- occur when firm has become too large and inefficient ( management becomes out of touch with the shop floor and machinery overmanned; decisions are not taken quickly; lack of communication; poor labor relations). External diseconomies of scale- occur when too many firms are located in one area ( local labour becomes scarce and firms must offer higher wages for new workers; local roads become congested and transport costs begin to rise). Making a strategic decision to expand, firms need to balance the effects of different sources of ES and DS so that the average cost of all decisions made is lower, resulting in greater efficiency. As output increases, costs of transporting goods to distant markets can increase enough to offset any economies of scale; a specific process within a company cannot produce the same quantity of output as another related process.

Trade based on product differentiation

A great deal of IT is intra-industry in differentiated products (DP)as opposed to inter-industry trade. DP- commodities that are not the same but that are substitutes for one other; are called also similar products. Intra-industry trade arises in order to take advantage of economies of scale in production and is based on product differentiation While trade based on CA is likely to be larger, the greater is the difference in factor endowments among nations, intra-industry trade is likely to be larger among economies of similar size and factor proportions. With differentiated goods produced under economies of scale, pretrade relative commodity prices may no longer predict the pattern of trade. A large nation may produce a good at lower cost than a smaller country in the absence of trade ( larger national economies of scale); with trade all nations can take advantage of ES to the same extent, and the smaller country could undersell the larger nation in the same commodity.

Natural or acquired comparative advantage (CA)

The intra-industry trade is related to the increase in IT in parts and components of a product; International corporations produce various parts of a good in different nations to minimize their costs of production ( the use of each nations CA as an extension of the basic H-O model to modern production conditions). Conclusion: CA the pattern of inter-industry trade; ES in differentiated products the pattern of intra-industry trade. The more dissimilar are Factor endowments ( as between developed and developing nations), the more important are CA and inter-industry trade- reflects natural CA; The more similar are factor endowments ( as among developed countries), the more important is intra-industry trade reflects acquired CA