ECO230Y1 Lecture Notes - Lecture 10: Zipper, Autarky, Protectionism

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Published on 30 Apr 2016
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External Economies of Scale
Economies of Scale
The traditional trade models assume that the production technology has no
economies to scale
As we assumed constant returns to scale for our trade models so far, while we will
assume production has increasing returns to scale technology.
Constant Returns to Scale: Q = Q(K,L)  Q(K,L)  Q
Increasing Returns to Scale : Q = Q(K,L)  Q(2K,2L)  3Q
It means, it all inputs are, say, doubled, output will be more than doubled. So, if
output increases  Average
Suppose we can produce the output by only labour force, at a wage of $30 per
worker
- Given that output can expand faster than inputs, there are economies of scale,
so average cost is falling as output scale rises
Economies of Scale and Supply Curve
Competitive Market:
Long run:
Excess profit = 0
 P= AC
 AC curve is the supply curve
 AC=S
Also so far, the traditional trade models assume that output comprises a
homogenous good, while we will assume that consumers prefer variety in goods
and producers create product differentiation.
- These newer models are based on two main concepts: increasing Returns
to scale and Product differentiation
- These models are complementary (not substitutive) of the traditional ones.
How can two similar countries with equal technology factor productivities, and
factor endowments trade?
Intuitive approach:
- Suppose there is a demand for a variety of goods
- Suppose there are economies of scale in production of each single variety
- In autarky all countries produce the whole quantities of all varieties, and
more likely to choose to produce fewer varieties.
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External Economies of Scale
- After the trade, countries specialize in varieties and produce the whole
quantity of a whole variety
- Each country produces and exports some varieties, and imports other
varieties
- Gains from trade: the same number of varieties can be produced cheaper, or
more varieties can be produced at the same cost
- Big countries can scale up production without giving up that many varieties
- Small countries can give up more varieties in order to scale up the
production of the rest of varieties. Of course they should import the varieties
that they don’t produce.
Economies of Scale
1. Internal Economies of Scale: average cost of production (unit cost) falls as
the size of the firm rises
industry becomes more to imperfectly competitive, as larger firms have
cost advantage
monopolies, oligopolies, or monopolistic competition
2. External economies of scale: Average cost of production (unit cost) falls as
the size of the industry, not necessarily the size of the firm rises
 industry consists of many small and competitive firms
Economies of Scale
For many years economists were wondering about the reasons behind the existence
of industrial clusters or industrial districts
- In the US: Banking and finance industry in New York City; Entertainment
industry in Hollywood; Gambling in Las Vegas High tech and semiconductor
industry in Silicon Valley
- In Europe: Banking and finance in London, Art and fashion in Paris, watches
in Switzerland
- Shipbuilding industry is mostly in South Korea and China
- Shipwrecking in India is clusteres in Aland, while information industry is
clustered in Banglor
- In China lighters are mostly produced in Wenzhou, while most of
buttons/zippers of the world are produced in Qiaotou
- In Madrid, Huertas street is the main party (pubs) street!!
1. Joint use of resources:
a. Concentrated and specialized suppliers, supplies and equipment:
Large concentration of silicon chip companies in Silicon Valley,
California
b. Factor endowment clusters use the same natural resources: Large
concentration of wine industry in a region due to specific
environmental factors good to grow grapes
c. Joint us of infrastructure: Ports, railroad, energy network
d. Proximity to demand centres: Clusters that emerged in developing
countries in such as automotive production, electronics, or textiles,
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Document Summary

The traditional trade models assume that the production technology has no economies to scale. As we assumed constant returns to scale for our trade models so far, while we will assume production has increasing returns to scale technology. Constant returns to scale: q = q(k,l) q(k,l) q. Increasing returns to scale : q = q(k,l) q(2k,2l) 3q. It means, it all inputs are, say, doubled, output will be more than doubled. Suppose we can produce the output by only labour force, at a wage of per worker. Given that output can expand faster than inputs, there are economies of scale, so average cost is falling as output scale rises. Also so far, the traditional trade models assume that output comprises a homogenous good, while we will assume that consumers prefer variety in goods and producers create product differentiation. These newer models are based on two main concepts: increasing returns to scale and product differentiation.

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