International eco: external eco of scale: left 8 part 3 (What happens to…
International eco: external eco of scale: left 8 part 3
What happens to supply and demand when production is subject to economies of scale?
What exactly happens depends on what is the main driver underlying the external economies of scale (e.g. knowledge spillovers affect productivity (growth), labor market pooling affects wages and unemployment)
But, without specifying what is the main driver underlying external economies of scale, the presence of external economies of scale
always means that:
The larger the industry, the lower its average production costs
Under perfect competition: prices reflect production costs
Because source of increasing returns to scale is external to each individual firm: production typically not dominated by few large firms, but many firms that compete with each other
The larger the industry, the lower the prices firms charge consumers for their products
What happens to supply and demand when production is subject to economies of scale? cont.
Normally (constant returns so scale) upward sloping: at lower prices firms are willing to supply less
Now: as production costs fall when an industry becomes larger, firms are willing to supply more at lower prices:
Forward-falling supply curve
This has implications for the supply curve:
Intuition: there are always additional firms willing to enter the market (expanding production), offering lower price to consumers
See graphs in notes (button china and US)
Very different from prediction Standard Trade model, where:
relative prices converge
If, in autarky, cars are relatively cheap in China and relatively expensive in the US, the effect of trade was to raise car prices in China and to reduce them in the US
Now: trade reduces prices everywhere.
Because of trade
prices fall in both countries!
Why? Production is much more efficient when locating in one country only, taking full advantage of the available external economies of scale
External eco scale and trade
Still, trade pattern determined by initial price differences between countries (country exports those goods that it initially produced cheaper than the other country)
What gives countries such initial advantage?
As in earlier CRS models: comparative advantage in technology or resource endowments (differences between countries)
But, the presence of external scale economies, also gives an important role to history (or chance)
How does this work?
Even in the absence of differences between countries, if a country “for some reason” was the first to attract an industry, this advantage has a tendency to get “locked-in”.
Once a location is producing a good, the external economies of scale kick in, and give it a productive advantage over another country that not yet produces this good
Would Frankfurt be one of the largest European airports
without the US military designating it their main airport
Would Silicon Valley be Silicon Valley if Hewlett and
Packard had started their business in Boston instead?
Would Eindhoven be the Dutch high tech-hub without
Anton en Gerard Philips starting to produce light-bulbs
there in 1891?
Ext. eco of scale Implications
Lock in may prevent more efficient producers from emerging
Amsterdam might in principle be a more efficient supplier of financial services, but because of London’s scale advantages the financial sector does not move there
The “wrong” location may end up producing things
Today, Brasilia is one of Brazil’s largest cities, and an important commercial hub. But, would it also be this without the Brazilian government moving there in 1960. What if resources used to build this city, were used elsewhere?
Rapid changes in the location of production are possible
If a country is able to reduce its production costs:
better educated workforce
or, the price of its good on world market falls for other reasons (lower transport costs)
it may result in rapidly attracting whole industries
Gains from trade?
Not all countries are necessarily better off with trade
A country may be better off producing everything for its own market rather than paying for imports