Unit 2: Why Trade?
Part 7: Economies
of Scale-Driven Trade
Economies of scale also drive trade specialization. An
economy of scale occurs whenever “bigger is better”
(or at least cheaper). That is to say, if a factory or an
entire industry can lower the average cost of producing
their products by producing more of them, then they are
operating within an economy of scale.
In general, two kinds of economies of scale influence patterns
of trade: internal economies of scale, which result from
the quantity produced inside the factory; and external economies
of scale, which result from the size of an entire industry
located in a particular place.
Internal economies of scale. We will first
explore the role of internal economies of scale on trade
by considering, for example, two types of automobiles: SUVs
and sports sedans. The factories that produce these automobiles
have huge research-and-development and assembly-line design
costs associated with producing each type of vehicle. Such
factories exhibit great potential for internal economies
of scale because larger production volumes of a given type
of automobile will spread out these “fixed”
costs, resulting in lower average costs per unit.
Now, let’s initially assume that the US and Germany
have identical factors of production—land, labor,
and capital—and that the two nations also have the
same preference for SUVs and sports sedans. According to
our analysis in the previous sections, and the fact that
similar preferences would result in similar quantities of
production, both the US and Germany should have the exact
same production costs (and no potential to gain from trade).
But what would happen if the relative preference for SUVs
and sport sedans were not the same? What if Americans like
SUVs because of the US’s low speed limits and big
parking lots, while Germans preferred the thrill (and safety)
of driving sport sedans on their no-speed-limit autobahns?
The German factory would make a few more sport sedans and
a few less SUVs, while the opposite would happen in the
US; this would make sports sedans cheaper to produce in
Germany and SUVs cheaper to produce in the US because of
the economies of scale being (or not being) realized.
To further exploit this cost saving, the US should just
specialize in what the majority of American’s want
(SUVs) and use the excess production of SUVs to trade for
what the minority of Americans want (sport sedans). Doing
this would reduce the development and assembly line set-up
costs and allow the citizens of both nations to buy automobiles
for less.
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| Diagram of internal economies of
scale. |
External Economies of Scale. An external economy
of scale is a cost advantage for an industry in a nation
that can more or less materialize by chance, but nonetheless
influences patterns of trade. For example, in the American
mid-west, an external economy of scale resulted from the
fact it just happened to be where Henry Ford’s first
“assembly line” auto plant was built. Once built,
other manufacturers, parts suppliers, laborers, transportation
grids, and such, also sprang up there. This agglomeration
of like-minded interests led to competition and cost savings,
which allowed Ford and the other automobiles factories located
there to produce cars at lower costs than anywhere else.
So, sometimes the reason a country trades one thing instead
of another is simply a matter of historical happenstance.
