Question

A. Explain what external and internal economies of scale are and why the supply curve in their case is shaped as “forward-falling”. B. What may cause one country to have an initial advantage from having a lower price? Discuss and give an example. C. Define what increasing returns to scale represents in the context of a production function. D. Can trade hurt a country when there are external economies of scale? Give an example with a 2-country 2-good model and illustrate in a graph to prove your point.

Answer 1

A.

Internal economies: When a firm expands its size of business or increases its output, it gets some advantages. They are called internal economies. These internal economies are related to a single firm and not related to other firms in the industry.

External economies: Firm is a unit, the group of firms is called industry. When industry is expended they are some advantages. These advantages are enjoyed by all the firms in the industry so they are called external economies. These economies are opened for all the firms, it means they are not related to a single firm.

In case of external economies and internal economies, the supplu curve shaped as," forward falling" because larger the industry's output, lower the price at which firms are willing to sell, as their average cost of production falls as indusstry output rises.

B.

There are many reasons due to which a country have initial advantage of lower price:

(1) A greater degree of competition leads to lower cost which enable a country to take advantage of lower cost.

(2) A country that has a absolute advantage can produce goods at a lower cost.

(3) If a country has a lower cost then its import will be increase due to its low price. Increasing in imports lead to increasing in revenue. Thus, due to increase in imports, a country also enjoy benefits of low cost.

C.

Increasing return to scale represent that proportionate increase in output is more than the proportionate increase in input. It menas wgen we double the input then the output will be more than the double.

D.

No, trade will not hurt the countries when there are external economies because larger firms have cost advantages over small firms. It will also increase the similarty in production, technology and factors of production. Hence external economies help in increasing the trade of a country. For example - when we compare brazil trade with germany, germany trade enjoy benefits in comparison of brazil.