Question

Assessment Question Week 6 Question 3:

Economies of Scale, Imperfect Competition and International Trade Trade need not be the result of comparative advantage but it can be a result of economies of scale. Discuss

Answer 1

It is true to a great extent that Trade need not be the result of comparative advantage but it can be a result of economies of scale. Comparative advantage is the ability to produce a good comparatively cheaper than another good and hence a country specializes in production of that good in which it has comparative advantage and they export that particular good.

Economies of Scale is the decrease in the cost of production of any particular good achieved by increasing the level of production. When a new firm is established it incurrs many types of cost including the fixed cost which is very high, so when firm produces small amount of good its average cost is very high but as production increases the fixed cost is spread over a large amount of goods and hence average cost falls and this is called decreasing returns to scale or economies of scale.

This economies of scale results in trade because as output increases to decrease cost it cant be consumed in the home market and hence it needs to be supplied to another market and hence exported. Another reason may be that the decrease in cost of production can itself generate comparative advantage to the firm or country as a whole.