Question

Explain the competitive advantage and economies of scale when it comes to international trade with case studies.

Why economies of scale is more important over comparative advantage when it comes to international trade?

300 words.

Answer 1

New trade theory (NTT) suggests that a critical factor in determining international patterns of trade are the very substantial economies of scale and network effects that can occur in key industries.

These economies of scale and network effects can be so significant that they outweigh the more traditional theory of comparative advantage. In some industries, two countries may have no discernible differences in opportunity cost at a particular point in time. But, if one country specialises in a particular industry then it may gain economies of scale and other network benefits from its specialisation.

Another element of new trade theory is that firms who have the advantage of being an early entrant can become a dominant firm in the market. This is because the first firms gain substantial economies of scale meaning that new firms can’t compete against the incumbent firms. This means that in these global industries with very large economies of scale, there is likely to be limited competition, with the market dominated by early firms who entered, leading to a form of monopolistic competition.

Comparative Advantage:A country has a comparative advantage if it can produce a good at a lower opportunity cost than another country. A lower opportunity cost means it has to forego less of other goods in order to produce it.If each country specializes in one producing good then assuming constant returns to scale, the output will double.

Limitation of the theory of comparative advantage

1. Transport costs may outweigh any comparative advantage
2. Increased specialisation may lead to diseconomies of scale
3. Governments may restrict trade
4. Comparative advantage measures static advantage but not any dynamic advantage for example in the future India could become good at producing books if it made the necessary investment