Question

Explain using the concept of dynamic increasing returns and learning curve why Switzerland still thrives in watch manufacturing even though a southeast Asian economy like that of Thailand could produce them more competitively. Do the results of the Ricardian model hold in this case?

Answer 1

Thailand and Switzerland could both manufacture watches, that Thailand could make them more cheaply, but that Switzerland has gotten there first.

is the world demand for watches, and, given that Switzerland produces the watches, the equilibrium is at point 1. the Thai demand for watches, . If no trade in watches were allowed and Thailand were forced to be self-sufficient, then the Thai equilibrium would be at point 2. Because of its lower average cost curve, the price of Thai-made watches at point 2, is actually lower than the price of Swiss-made watches at point 1, .

We have presented a situation in which the price of a good that Thailand imports would actually be lower if there were no trade and the country were forced to produce the good for itself. Clearly in this situation, trade leaves the country worse off than it would be in the absence of trade. There is an incentive in this case for Thailand to protect its potential watch industry from foreign competition.

External economies can sometimes lead to disadvantageous patterns of specialization and trade, it’s virtually certain that it is still to the benefit of the world economy to take advantage of the gains from concentrating industries.

Suppose that a country could have low enough costs to produce a good for export if it had more production experience, but that given the current lack of experience, the good cannot be produced competitively. Such a country might increase its long-term welfare either by encouraging the production of the good by a subsidy or by protecting it from foreign competition until the industry can stand on its own feet. The argument for temporary protection of industries to enable them to gain experience is known as the infant industry argument