CAP 7

Questão 1

Internal economies of scale:

Internal economies are those economies in production which occur to the firm
itself when it expands its output or enlarge its scale of production.

External economies of scale:

External economies refer to all those benefits which accrue to all the firms
operating in each industry. External economies of scale increase the productivity
of an entire industry, geographical area or economy. External factor are outside
the control of a particular company. Generally, these economies accrue due to
the expansion of industry and other facilities expanded by the Government.

a)

When a number of firms doing contract research for the drug industry are
concentrated in southeastern South Carolina, it is external economies of scale as
costs decreases due to size of the industry and its concentration in a locality.
Thus, it is an external economy of scale.

b)

It is an outsourcing from the company’s own plant in the company B. Thus, it is

an internal economy of scale.

c)

All airframes for Airbus, the only producer of large aircraft in the continent are
assembled in Toulouse; France is the internal economy. Thus, it is an internal
economy of scale.

d)

Cranbury, NJ is the artificial flavor capital of the country U is the external

economies of scale as there are many firms in that locality. Thus, it is an external
economy of scale.

Questão 2

The existence of increasing returns in any country can be due to external

economies of scale or internal scale of economies. In the external economies of
scale, the per unit cost of output depends on the industry size. While, in the case
of internal economies of scale the per unit cost of output depends on the firm size.
In today’s world, the major economies around the globe have experienced growth
due to external economies of scale. There are many countries which are in
conflict because countries are favoring the concentration of production of an
industry in just few locations.The countries are favoring external economies due
to:

1. Specialized equipment or services: The availability of specialized cheaper and

accessible machinery improves the production process.

2. Labor pooling: When the countries are concentrated in a specific region, it may
attract a pool of workers which reduces the hiring cost and employee search cost.

3. Knowledge Spillover: The exchange of knowledge between workers is easy

when a concentrated and large industry exists.

There are conflicts between the countries as the trade based on the external
economies has an ambiguous effect on the nation’s welfare.

There is a possibility that a country is worse off with trade: A country may
be better off if it produces all the goods and services on its own rather than
importing from other countries. The countries experiencing the external
economies of scale can always produce different goods and services at a lower
cost and thus sell the goods at a lower price level in the world market. This makes
the survival of the other country’s industries difficult.

The pattern of trade may exist due to historical accidents: It is argued that
the countries which start as a large producer in certain industries may continue
to remain a large producer even though the other country can produce the same
good at a cheaper price. Thus, a major reason behind the conflict for the trade
based on external economies of scale is for the fact, that the external economies
does not guarantee that the right country will produce a good.

Questão 3

The most important products which are traded internationally, and experience
dynamic increasing returns are Software services and Motion pictures. In both
the sectors continuous innovation helps in reducing the cost for cumulative output
rather than current output. It is also a process of continuous learning-by-doing;
especially filmmaking. The experience gained through production effects the
cost. When individual firms in software sector and filmmaking improves its
products or production techniques through experience, other firms are likely to
imitate the firm and benefit from its knowledge. This spillover of knowledge gives
rise to a situation in which production costs of individual firm falls as the industry
as a whole gathers experience.

Questão 4

a) It clearly indicates the economies of location. If most of the world’s aluminum

smelting is done in specific location, it will lead to external economies. All the
firms of the industry will receive cost benefits. If the firms operations are large,
there are chances of internal economies. These will definitely lead to cost
advantage over small firms and lead to an imperfectly competitive market
structure.
(b) This is a case of internal economies where the jet aircraft industry will enjoy
the benefits of comparative cost advantage over small firms and lead to an
imperfectly competitive market structure. So the production takes place by small
number of imperfectly competitive firms at limited locations like Seattle. (c)
Industries like semiconductor production consists of many small firms and
perfectively competitive which are concentrated in certain specific location. These
are subject to external economies which result in trade.

(d) It is a case of comparative cost advantage. Scotland is geographically and

climatically suitable for the natural input required in whisky production. Moreover,
the labor force of Scotland is experts in the technique of production of whisky.

(e) It is also a case of comparative cost advantage. France is also unique in

production of wine. The climate and quality of its natural resources are favorable
for wine production which is rare in other countries.

Questão 5

(a) If two countries produces same good and have identical average costs, then
their supply curves are given as forward-falling supply curves. The larger the
industry’s output, the lower the price at which firms are willing to sell, because
their average cost of production falls as industry output rises-are also identical as
shown in the figures below:

In the above case, the answer to the expected pattern of international

specialization and trade depends upon historical contingency. When something
gives a particular location an initial advantage in a particular good, then all the
production will take place in that country only and that country will export to the
rest of the world. This is because the initial advantage is locked in external
economies of scale in the production of that industry.

(b) The benefits from trade is not limited to the country where the industry is
located but benefits are conferred on both the countries because the after trade
price is much lower than the autarky price in both the countries. The reason for
this reduced price everywhere is that when there are external economies of scale,
international trade makes it possible to concentrate world production in a single
location (in a single country here), and therefore to reduce costs by reaping the
benefits of even stronger external economies.

Questão 6

Industries with close economic links form industrial clusters. The complications
and diversification of economic links among industries generates external
economies. These external economies are important for the firms of the various
industries as technology of the industry is on high standard and innovations are
creating a cutting edge over others. Now, when technology become obsolete,
slow and outdated, the production process becomes monotonous and lacks the
cutting edge. This reduces the advantages generated by the external economies
– knowledge spillover, specialized suppliers and labor market pooling. In such
case, the industries find no use in being clustered. So, the industries break up to
move to a low cost production location where there is low wage skilled labor.

Questão 7

China is generally a labor-abundant economy compared with developed

economies. Mainly labor-intensive goods are produced by highly localized
industries that benefits strongly from external economies of scale. Therefore, it
has the initial advantage in producing labor-intensive goods by possessing
external economies of scale. The growing labor shortage in China has been
causing an increase in the wage rate in the country. The high wage rate increases
the cost of production in China making goods dearer. Furthermore, it is reducing
the advantages of external economies that accrue to the Chinese industries.
Nevertheless, historical contingency determines the pattern of specialization and
trade in industries with external economies. Moreover, historical accident can
give persistent external economies of scale in-spite of a prevailing low-cost
manufacturer. Therefore, although China produces goods costlier than other
countries like Vietnam, China’s head start enabled it to hold on to the industry.
Thus, once a country has established an advantage in an industry, it may retain
that advantage even with the existence of other low-cost manufacturing
countries. The below figure gives the importance of establishing initial advantage:
The importance of established advantage for China.

The average cost curve for other country, ACother, lies below the average cost
curve for China, ACChina. In the above figure, other country has a lower average
total cost than china. However, as the industry established first in China, it is able
to produce the output at P1 due to the existence of external economies. On the
other hand, if a company from other country starts its production, then it has to
produce at a cost Co that is higher than P1. Thus, due to the non-existence of
external economies of scale the low-cost country could not able to take over
China.

Questão 8

Labor market pooling is one of the main sources of external economies. It can
consistently supply labor to the producers and can assure regular employment
for the laborers when two firms are located in the same place, one is expanding
while the other is contracting. But when both firms are expanding or contracting
at the same time in the same location, the supply of labor will be affected
accordingly. This can be explained through the following example: If both the
firms are expanding at the same time, then the labor supply cannot meet the
requirement. For instance, each expanding firm will demand 150 laborers, adding
total to 300, while the labor supply limit is 200 only. So, there will be dearth of
labor. The producers will be negatively affected as they have to pay high wage to
employ the scarce labor while the laborer will benefit. On the other hand, if both
the firms are contracting at the same time, then the labor supply will be in excess
of requirement. For instance, each contracting firm will demand only 50 laborers
that is a total of mere 100, while the available supply of labor is 200. So, there
will be excess of labor in the market. This will lead to unemployment in the
location. Therefore, in such a case, geographical concentration and the resultant
labor market pooling is not favorable for external economies.
Questão 9

(a) Software tech-support services are subjects more too external economies of
scale than to dynamic increasing returns because this service needs a skilled
labor market pooling. At the same time, these services also require constant
innovation and learning which reduces the costs on cumulative output (that is
dynamic increasing returns).

(b) Production of asphalt or concrete is less subject to both external economies

and dynamic increasing returns. It is difficult to assess how the firms in the
industry influence each other’s cost and firms in such industries require more or
less a stable technology.

(c) Motion pictures are the most likely to subject both external economies and
dynamic increasing returns. It leads to development of large number of ancillary
firms and also forms a skilled labor market pool. This industry always requires
constant learning- by- doing.

(d) Cancer research is more subject to dynamic increasing returns than external
economies of scale. It requires constant research and development which
improves the learning process and leads to innovation. Moreover, its research
and knowledge experience may help other firms also.

(e) Timber harvesting is less subject to both external economies and dynamic
increasing returns. It does not count how the presence of one extra firm will affect
the other firms in the industry. Moreover, this industry needs more or less stable
technology