External Economies of Scale and Location (sec 8)

Question 1

Two countries have identical production technology with decreasing average costs due to external economies of scale.
a) What do you expect with regard to the specialization and the trade pattern?

Answer 1

Setting : Lower production costs for China compared to US, due to historical accident, economic policy, comp. advantage..)
- Under trade the entire production will shift to China
- China saves the global market with quantity Q1 at price P1 (only exporter of buttons)
- Price is lower than both national prices under autarky

Question 2

What are the advantages of international trade in this case? Is it only the producing country
that benefits?

Answer 2

• This may free resources in the USA which can be used in other production activities

=> Both countries benefit from trade

Question 3

Same example where this does not hold

Answer 3

China as a ‘first mover’ in the production of buttons
- A third country (Vietnam) could theoretically produce buttons at a lower average cost , but just extended the market
- Yet it cannot enter the market due to the established advantage (economies of scale)
- There might be inefficient trade

=> in this specific case Vietnam might be better off not trading or temporarily protecting it’s industry (‘Instant industry agreement’)