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International eco: External eco of scale Lect 8 part 1 (Increasing returns…
International eco: External eco of scale Lect 8 part 1
Intro
=> Trade is the result of differences in comparative advantage
But… (remember Lecture 1): a substantial part of trade is among developed nations
These are typically very similar in relative technologies and endowments --> difficult to explain with Ricardian and H-O model
Explanations for trade we discussed so far: a result of differences in countries’ production possibilities
differences in Technology (Ricardo)
(also sfm)
differences in Resource Endowments (H-O)
Possible explanation:
Increasing returns to scale
if present, they provide an incentive to countries to specialize in certain products
importing goods it does not specialize in
exporting goods it specializes in in return
Returns to scale
: so far models constant returns
so far models constant returns,doubling all inputs, doubles total output
In Ricardian model
: labor only factor of production. When increasing the amount of labor by x%, output goes up by x%, no matter how many workers already employed
In Heckscher-Ohlin model:
two factors of production (labor and capital). When increasing both the amount of workers and machines by x%, output goes up by x%, no matter how many workers or machines already employed
but, didn’t we talk about diminishing returns to labor and capital in the H-O and the S-F model ?
Returns to scale vs. returns to one factor
Yes, we did, but when production requires more than one factor input:
Diminishing returns to one factor = when only that factor input is increased by x%, output rises by less than x%
this is NOT the same as
Diminishing returns to scale = when all factors’ input is increased by x%, output rises by less than x%
Constant returns to scale and diminishing returns to each factor involved in production
do not contradict each other
Example:
Initially I produce 10 computers using 10 workers and 10 machines
Suppose
I only double the # workers
: 2 workers per machine
=> more workers have to share one machine, making them less effective: output only goes up to 14 computers
Suppose
I only double the # machines:
1 worker per 2 machines
=> each worker has to operate 2 machines at the same time, making them less effective: output only goes up to 14 computers
Now I double both the # workers and machines:
still 1 worker per machine => workers and machines as effective as before: output also doubles to 20 computers
Increasing returns to scale
If production characterized by constant returns to scale:
relative prices will be the same in both countries
No
incentive to trade!
But, as we saw, developed countries do trade!
If no differences in resource endowments or technologies between countries
Important explanation: production of many goods does not happen under constant returns to scale, but instead exhibits
increasing returns to scale
Increasing returns to scale or economies of scale:
when
all
inputs to an industry increase by x%, output increases by
more than
x%
a larger scale is more efficient: the cost per unit of output falls as a firm or industry increases output
EXAMPLE slide 10-11
Increasing returns to scale (cont.)
Using the available resources in one (or a few) sectors only, makes them more productive than using them in many different sectors
When production is characterized by increasing returns to scale, it pays to specialize:
Trade can be mutually beneficial:
it facilitates countries to specialize (they can specialize in some goods, importing the rest from other countries that specialize in other goods)
if it needs to make everything itself, it can not benefit from increasing returns to scale in production