Chapter 7 Solution PDF

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International Trade, Problem set of chapter 7...

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1. For each of the following examples, explain whether this is a case of external or internal economies of scale: a) A number of firms doing contract research for the drug industry are concentrated in southeastern South Carolina. b) All Hondas produced in the United States come from plant in Ohio or are imported. c) All airframes for airbus, Europe’s only producer of aircraft, are assembled in Toulouse, France. d) Cranbury, New Jersey, is the artificial flavor capital of the United States. External economies of scale: Cases a, and d. the productions of these two industries concentrate in a few locations and successfully reduce each industry's costs even when the scale of operation of individual firms remains small. External economies need not lead to imperfect competition. The benefits of geographical concentration may include a greater variety of specialized services to support industry operations and larger labor markets or thicker input markets. Internal economies of scale: Cases b and c. Both of them occur at the level of the individual firm. The larger the output of a product by a particular firm, the lower its average costs. This leads to imperfect competition as in petrochemicals, aircraft, and autos Concept of External and Internal economies of scale: • External Economies of Scale: The cost per unit depends on the size of the industry but not on the size of the firm. • Internal Economies of Scale: The cost per unit depends on the size of an individual firm but not on the size of the industry 2. It is often argued that the existence of increasing returns is a source of conflict between countries, since each country is better off if it can increase its production in those industries characterized by economies of scale. Evaluate this view in terms of both the monopolistic competition and the external economy models. Both internal economies of scale (which may lead to monopolistic competition) and external economies of scale could lead to increasing returns. By concentrating the production of each good with economies of scale in one country rather than spreading the production over several countries, the world economy will use the same amount of labor to produce more output. In the monopolistic competition model, the concentration of labor benefits the host country. The host country can capture some monopoly rents. But the rest of the world may hurt and have to face higher prices on its consumption goods. In the external economies case, such monopolistic pricing behavior is less likely since imperfectly competitive markets are less likely 3. Give two examples of products that are traded on international markets for which there are dynamic increasing returns. In each of your examples, show how innovation and learning-bydoing are important to the dynamic increasing returns in the industry. Dynamic increasing returns occur whenever average costs fall with cumulative output. In other words, a learning curve exists that favors established producers over startups. This is an openended question, though the examples in Question 9 provide some ideas. Two industries characterized by dynamic increasing returns are biotechnology and aircraft design. Biotechnology is an industry in which innovation fuels new products, but it is also one where learning how to successfully take an idea and create a profitable product is a skill set that may require some practice. Aircraft design requires innovations to create new planes that are safer or more cost efficient, but it is also an industry where new planes are often subtle alterations of previous models and where detailed experience with one model may be a huge help in creating a new one.

4. Evaluate the relative importance of economies of scale and comparative advantage in causing the following: a) Most of the world´s aluminum is smelted in Norway or Canada. The relatively few locations for production suggest external economies of scale in production. If these operations are large, there may also be large internal economies of scale in production. b) Half of the world´s large jet aircraft are assembled in Seattle. Because economies of scale are significant in airplane production, it tends to be done by a small number of (imperfectly competitive) firms at a limited number of locations. One such location is Seattle, where Boeing produces airplanes c) Most semiconductors are manufactured in either the United States or Japan. Because external economies of scale are significant in semiconductor production, semiconductor industries tend to be concentrated in certain geographic locations. If, for some historical reason, a semiconductor is established in a specific location, the export of semiconductors by that country is due to economies of scale and not comparative advantage. d) Most Scotch whiskey comes from Scotland. “True” scotch whiskey can only come from Scotland. The production of scotch whiskey requires a technique known to skilled distillers who are concentrated in the region. This labor market pooling suggests external economies of scale. Also, soil and climactic conditions are favorable for grains used in local scotch production. This reflects comparative advantage. e) Much of the world´s best wine comes from France. France has a particular blend of climactic conditions and land that is difficult to reproduce elsewhere. This generates a comparative advantage in wine production. 5. Consider a situation similar to that in Figure 6-9, in which two countries that can produce a good are subject to forward-falling supply curves. In this case, however, suppose that the two countries have the same costs, so that their supply curves are identical. a. What would you expect to be the pattern of international specialization and trade? What would determine who produces the good? P,C

P,C

External Economics and Specialization

External Economics and Specialization

AC

AC

AC D

AC D Q

Q

Suppose two countries that can produce a good are subject to forward-falling supply curves and are identical countries with identical curves. If one country starts out as a producer of a good, i.e. it has a head start even as a matter of historical accident, then all production will occur in that particular country and it will export to the rest of the world.

b. What are the benefits of international trade in this case? Do they accrue only to the country that gets the industry? Consumers in both countries will pay a lower price for this good when external economies are maximized through trade and all production is located in a single market. In the present example, no single country has a natural cost advantage or is worse off than it would be under autarky. 6. It is fairly common for an industrial cluster to break up and for production to move to locations with lower wages when the technology of the industry is no longer rapidly improving – when it is no longer essential to have the absolutely most modern machinery, when the need for highly skilled workers has declined, and when being at the cutting edge of innovation conveys only a small advantage. Explain this tendency of industrial clusters to break up in terms of the theory of external economies. The three forces driving external economies of scale are access to specialized suppliers, labor market pooling, and knowledge spillovers. As these forces weaken, so too do the cost advantages of geographic clustering. The location of production becomes increasingly driven by factor costs when industries move away from external economies of scale toward traditional constant returns to scale. 7. Recently, a growing labor shortage has been causing Chinese wages to rise. If this trend continues, what would you expect to see happen to external economy industries currently dominated by China? Consider, in particular, the situation illustrated in Figure 7-4. How would change take place? From the figure 7.4 we can see that if the wages keeps on rising there are other countries like Vietnam which can supply labor at a demand required at a much lower price. So, naturally the output produced from china will be shifted to other countries and the dominance of China i likely to be reduced. 8. In our discussion of labor market pooling, we stressed the advantages of having two firms in the same location: if one firm is expanding while the other is contracting, it’s to the advantage of both workers and firms that they be able to draw on a single labor pool. But it might happen that both firms want to expand or contract at the same time. Does this constitute an argument against geographical concentration? (Think through the numerical example carefully.) Consider again two different scenarios: In scenario 1, there are two firms in the same location and a local labor supply of 200 for both firms. In scenario 2, the two firms are far apart, and each firm has a local labor supply of 100. Now suppose that both firms are expanding, increasing their demand for labor up to 150 each. In the first case, each firm will face a local labor shortage of 50 workers (assuming each firm is able to hire 100 workers). In the second case, each firm will experience the same local labor shortage of 50 workers! Thus, locating next to each other does not present any disadvantages over locating far apart when both firms are expanding. There still is, however, an advantage when one firm is expanding and the other is contracting. 9. Which of the following goods or services would be most likely to be subject to (1) external economies of scale and (2) dynamic increasing returns? Explain your answers. a) Software tech-support services External economies of scale are likely due to the need to have a common pool of labor with technical skills. Dynamic increasing returns may be likely due to the need for continual innovation and learning.

b) Production of asphalt or concrete External economies are unlikely because it is difficult to see how the costs of a single firm would fall if other firms are present in the asphalt industry. Dynamic increasing returns are also unlikely as the asphalt industry is pretty well established and learning curves are likely to be low. c) Motion pictures External economies are highly likely because having a great number of support firms and an available pool of skilled labor in filmmaking are critical to film production. Dynamic returns are also likely because filmmaking is an industry in which learning is important. d) Cancer research External economies are somewhat likely in that it may be advantageous to have other researchers nearby. Dynamic returns are highly likely because such research builds on itself through a learning-by-doing process. e) Timber harvesting External economies are somewhat likely if there are a set of skills unique to the timber industry that would lead to a clustering of timber firms and timber workers. Dynamic returns are unlikely as the technology used in timber harvesting is relatively stable (i.e., a low learning curve)....