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Economies Of Scale, Imperfect Competition And International Trade

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Question:

Discuss about the Economies of Scale, Imperfect Competition and International Trade.
 
 

Answer:

Introduction

It can be evident that market structure and economies of scale have considerable impacts on the pattern of trade and comparative advantage of a nation. There are several assumptions of perfect competition used by the classicist to determine the elements of international trade theory. The study presents a relation between economies of scale and imperfect competition with international trade (Dakhlia and Temimi, 2016). Recently, different theories have been presented by various authors that deal with the economies of scale and imperfect competition to present a general equilibrium framework that modifies the modern theory of international trade (Winters and Wells, 2012). Some authors concentrate of existence of gains and equilibrium from trade in the imperfect competition model, whereas some focuses on differentiation of product as the key to success. It has been believed that differentiation leads to gains from intra-industry trade. Considering the concept of intra-industry trade, it can be seen that maximum benefits are derived from trade between similar countries (Findlay, 2014). Hence, the study has been developed to conduct a theoretical analyse and establish a relationship between economies of scale and imperfect competition with intra-industry trade. Furthermore, the study emphasises on expansion and application of the theories in real world to get benefited from international trade. Hence, the purpose of the study is to present a literature review and explain the theories to understand their importance in international businesses to seek growth over the global platform.

External and internal economies of scale

Economies of scale present the comparative advantage that can be sought by production of such commodities in which the country has better specialisation (Fujita, 2008). Hence, Economies of scale can be termed as the advantages that a company or nation seeks through large scale production. The economies of scale has been categorised into two segments. One is known as internal economies of scale and the other is known as external economies of scale.

Economies of Scale

Figure: Economies of Scale

Source: (Jensen and Wong, 2007)

The two different concepts of economies of scale or benefits of mass scale production have been discussed herein below:

Internal economies of scale

The internal economies of scale occurred due to expansion of business and increase in production. It leads to decrease in the production costs that provide the company with a competitive edge (Krugman, 2010). Internal economies of scale occur within the firm due to its expansion of business. The internal economies of scale can be categorised into real economies of scale and pecuniary economies of scale that are discussed herein below:

 

Real economies of scale

The real economies of scale are presented herein below

  • Technical economies: Large firm enjoys higher efficiency in terms of technology from machinery and capital goods.
  • Marketing economies: Large amount of money can be spent on marketing activities, yet per unit cost of marketing remain low.
  • Labour economies: Large scale production provides labour economies because per unit labour cost reduces.
  • Managerial economies: It leads to reduction in the per unit managerial cost due to large scale production.
  • Economies of transport and storage: Large firm enjoys economies of transport and storage with higher level of productivity.

Pecuniary economies

The pecuniary economies of scale are presented herein below:

  • Large firms can buy raw materials at a lower price due to special discounts offered by the suppliers
  • Large firms are offered with easy loans from banks at lower interest rates.
  • Large firms seek concessional transport facilities due to bulk amount of goods.
  • Large scale firms enjoy low cost of advertising due to bulk production.

External economies of scale

External economies are the benefits that are accrued by the firms due to large scale operations in a particular industry. The external benefits are shared by a number of firms operating in a particular industry. The external economies are presented herein below:

  • Economies of concentration: The large firms enjoy the benefits of communication and transport, research and invention and raw materials availability with increase in number of firms in an industry (Lo and Fann, 2010).
  • Economies of information: The increase in number of firms makes the industry mutually dependent. It leads to easy flow of information from one firm to another for mutual benefit.
  • Economies of disintegration: With development of industry, every firm specialises in production of particular products. Hence, mutual understanding leads to economies of scale large production (Melvin, 2009).

Importance of economies of scale

The importances of economies of scale are presented herein below:

  • Nature of Industry: It helps to determine the nature of industry. For example, constant cost industry, increasing cost industry and decreasing cost industry (Mai and Hwang, 2007).
  • Analysis of cost of production: It helps to analyse the cost of production by judging the benefits of large scale production.
 

Imperfect competition and trade

The monopolistic competition model

The assumption of perfect competition has been overtaken by monopolistic competition model that presents an imperfect competitive situation in international trade. The monopolistic competition model can be derived by the presence of many small businesses that operate with their own policies and strategies. In a monopolistic competitive market every organisation makes it own decision regards to the products, output and pricing. The entrepreneurs play primary role in the market because of high risk involved in decision making. Furthermore, there is no barrier to enter or exit the market. Along with that, the differentiation strategy is not limited to product, but the entrepreneurs can implement differentiation of marketing strategy, human capital and distribution techniques. According to this model, the firms are the price makers due to immense rate of competition in the market. Hence, it can be seen that the firms make a huge supernormal profits in the short run that decreases in the long run due to adoption policy and entry of new competitors.

The intra-industry trade

The intra-industry trade has been often identified as one of the favouring practical elements in substantial trade theories. By considering the imperfect trade competitions across the global trade industry, organisations have seemed to secure significant returns on investment in compared to perfect competition scenario.  In case of intra-industry trade analysis, significant rudiments of Ricardian trade theory can be applied within the Heckscher-Ohlin framework (Davis, 2015). Through the identification of the benefits of intra-industry trade, the paper has been described to evaluate the competitive advantage of such trade. Meanwhile, the traditional theories of proportional advantage have been taken into consideration to identify the contrast scenario of the scale economies model (Bergstrand, 2010). Through the understanding of scale economies perspective, intra-industry trade can provide return to scale in an efficient way.  In the contemporary business scenario, scale economies have influenced the rise of intra-industry trade though the relation between substitutes for scale economies and intra-industry trade has shown negative impact (Aquino, 2011).  Meanwhile the return of scale economies has been identified one of the most successful element to select intra-industry trade contributing to the maximum profitability of the global business enterprises. Arguably, the introduction of intra-industry trade has improvised business specialisation so that contemporary businesses can increase imperfect competition for further benefits and profitability.  Moreover, the intra-industry trade pattern has got significant wide spread acceptance to understand the role of the theories on comparative advantage (Greenaway and Milner, 2011).  According to the Ricardian model, economies of scale have been neglected in the large trade flows promoting sustainability.

Measurement of intra-industry

Grubel and Lloyd present the method to measure Intra-Industry trade of a nation. The measurement of intra-industry trade is known as Grubel-Lloyd index (Chipman, 2010). A formula has been presented below to measure the intra-industry trade of a country.

Measurement of intra-industry

The measurement of intra-industry trade is required to understand the opportunities of trade in an international market. It is important to note that every nation is not specialised in production of all commodities. Hence, every nation export particular commodities to other nations in which it have comparative disadvantage. On the other hand, it exports those products in which it has comparative advantage. Hence, the measurement of Grubel-Lloyd index helps in observing the trade opportunities in different countries to plan the internationalisation strategies to enter those markets.

 

External economies and international trade

External economies of scale have held the key to success at the industry level to set remarkable trade standards. By considering the international trade theory, external economies of scales have derived significant factors to support international trade. Meanwhile, whenever economies of scale have been applied at the industry level rather than m enterprise level, it can be identified as external economies. Moreover, in larger business perspective, external economies have been utilised to influence the international trade prospects in countries such as the United States of America, China and other major countries (Suga, 2007). On critical thinking perspective, external economies of an international market must be identified following thorough research so before affirmative decision-making on international trade policy.  Through the identification of sustainable external economies of scale attached to a target market can improve the trade relations between two countries (de Groot and Nahuis, 2012). Furthermore, as the expansion of trade can be materialised in the target market, the output of the industry will be automatically enhanced due to the present of affordable external economies of scale. Moreover, the international trade and external economies have been significantly benefitted through the implementation of theoretical concepts attached to the scenario of external economies of scale (Ohlin, 2007). The connection point of business and trade perspectives can create new dimensions to be opened up for further trading perspective at the international platform (Sullivan, 2013).

Understandably, the external economies can increase the productivity of the industry. As the output of the industry will increase, the costs of the external economies and available market patterns will experience an upward lift. Meanwhile, a discussion on comparative advantage can be evident to explain the trade patterns. As external economies have influenced comparative advantage in the market, a pattern related to industry specialisation can be identified on a historical contingency (Milner, 2008). As the external economies have picked up robust growth model in a relevant industry, the initial advantages will dried up. Therefore, the advantages of the primary stages will be locked in. In such circumstances, the external economies will be no longer relevant to the industry as functionality of the same will be reduced. Evidently, selection of the right country will be manifest for international trade reviewing the external economies for long-run success at the international level (Tangkittipaporn and Songkroh, 2009).

Extension and applications

New theories have been developed by economist in respect to economies of scale. It includes the horizontal and vertical integration of economies of scale (Brakman and Heijdra, 2014). Horizontal perspective presents the quality developed, whereas vertical perspective presents other benefits of intra-industry trade. Furthermore, new approaches of international trade model have been developed by Dixit and Stiglitz, which is known as the new trade theory (Brakman and Heijdra, 2014). Along with that, the Core-Periphery Model has been developed to analyse the concentration and specialisation of particular economy. Hence, these extensions of theoretical models can be applied in the real world scenario to develop international trade patterns relevant for significant economies.

 

Conclusion

The dynamic scenario of economies of scale has significantly contributed towards successful management of trade perspective. Identically, the internal and external economies of scale have influenced the international trade at the highest business level. By providing effective changes in international trade procedure, countries with similar types of economies of scale can create sustainable long-run trade relationship. On the other hand, on basis on intuitive views, equal productivity, factor endowments and other significant concepts must be identified through the identification of economies of scales. Moreover, because of the presence of economies of scale, significant international trade concepts can be determined. In this way, international trade can be made possible in the two different countries having different types of economic standards. Moreover, the fundamental objective of return has been fulfilled by utilising both the internal and external economies of scale. Through the identification of classical models such as Ricardian Model and Heckscher-Ohlin Model (H-O Model), comparative advantage and business gains in international trade can be achieved. Furthermore, the specialised goods and intensives services must be endowed according to the factors influencing the business prospects at the global platform. Conclusively, the contribution of economies of scale in international trade can identify the most effective cost structures and sustainable business framework applicable for maximum profitability.

 

References

Aquino, A. (2011). The measurement of intra-industry trade when overall trade is imbalanced.Weltwirtschaftliches Archiv, 117(4), pp.763-766.

Bergstrand, J. (2010). The Heckscher-Ohlin-Samuelson Model, The Linder Hypothesis and the Determinants of Bilateral Intra-Industry Trade. The Economic Journal, 100(403), p.1216.

Brakman, S. and Heijdra, B. (2014). The monopolistic competition revolution in retrospect. Cambridge, UK: Cambridge University Press.

Chipman, J. (2010). External Economies of Scale and Competitive Equilibrium. The Quarterly Journal of Economics, 84(3), p.347.

Dakhlia, S. and Temimi, A. (2016). An Extension of the Trade Restrictiveness Index to Large Economies. Rev International Economics, 14(4), pp.678-682.

Davis, D. (2015). Intra-industry trade: A Heckscher-Ohlin-Ricardo approach. Journal of International Economics, 39(3-4), pp.201-226.

de Groot, H. and Nahuis, R. (2012). Optimal Product Variety and Economic Growth: The Trade-off between Internal and External Economies of Scale. Journal of Economics, 76(1), pp.1-32.

Findlay, R. (2014). International economics. Journal of International Economics, 4(3), pp.318-319.

Fujita, M. (2008). A monopolistic competition model of spatial agglomeration. Regional Science and Urban Economics, 18(1), pp.87-124.

Greenaway, D. and Milner, C. (2011). Trade imbalance effects in the measurement of intra-industry trade. Weltwirtschaftliches Archiv, 117(4), pp.756-762.

Jensen, B. and Wong, K. (2007). Dynamics, economic growth, and international trade. Ann Arbor: University of Michigan Press.

Krugman, P. (2010). Rethinking international trade. Cambridge, Mass.: MIT Press.

Lo, C. and Fann, G. (2010). Globalisation strategy: foreign direct investment or international outsourcing trade?. International Journal of Management and Enterprise Development, 9(2), p.147.

Mai, C. and Hwang, H. (2007). External Economies of Scale and Optimal Plant Location. Pacific Economic Rev, 2(2), pp.115-124.

Melvin, J. (2009). Trade in Producer Services: A Heckscher-Ohlin Approach. Journal of Political Economy, 97(5), pp.1180-1196.

Milner, C. (2008). Weighting considerations in the measurement and modelling of intra-industry trade.Applied Economics, 20(3), pp.295-301.

Ohlin, B. (2007). Interregional and international trade. Cambridge, Mass.: Harvard University Press.

Sivagama, S., Vadhiyar, S. and Nanjundiah, R. (2009). Dynamic Component Extension: a Strategy for Performance Improvement in Multicomponent Applications. International Journal of High Performance Computing Applications, 23(1), pp.84-98.

Suga, N. (2007). A monopolistic-competition model of international trade with external economies of scale. The North American Journal of Economics and Finance, 18(1), pp.77-91.

Sullivan, A. (2013). A general equilibrium model with external scale economies in production. Journal of Urban Economics, 13(2), pp.235-255.

Tangkittipaporn, J. and Songkroh, M. (2009). International trade management competencies.International Journal of Management and Enterprise Development, 6(1), p.136.

Winters, L. and Wells, S. (2012). International economics. London: Routledge.

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