Question

Distinguish between the external return to scale and internal return to scale. How does the new trade theory of economic returns to scale differ from the traditional trade theories like Ricardian model, and Heckscher - Ohlin model? 3. 4. What is the Rybczynski theorem? How does theorem predict changes in factors usage in production and change in trading volume if there is an influx of immigrant?

Answer 1

1. An Internal economy of scale is the result of company's efficiency in production. It refers to the efficiency achieved by the firm in by increasing its output and reducing per unit average cost of the product. It is firm specific and it arises due to internal factors. Such economies are result of company's size and is controlled by its management teams such as workforce, production measures, and machinery.

An External economy of scale is the result of the positive expansion of the industry as a whole. It is industry specific. It occurs when whole industry grows as a whole and the firms benefit from long run average costs. It occurs outside the firm but within the industry.Example IT industry in silicon valley which has attracted employees with specialized skills. Another example could be certain industries may become so important and powerful that they can develop bargaining power with politicians and local governments.

Difference between new and old theories:

• According to new theory substantial economies of scale and network effects plays an important role in determining international patterns of trade. This can be so effective that it can overpower the traditional theory of comparative advantage.n some industries, two countries may have no discernible differences in opportunity cost at a particular point in time. But, if one country specializes in a particular industry then it may gain economies of scale and other network benefits from its specialization.
• New theory also emphasizes on the importance of early entrants.Such a firm can attain dominant position in the market. This is because being the first firm it will enjoy benefits of large economies of scale and new firms cannot 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.

2. Rybczynski Theorem states that the increase in the supply of one of the factor of production, other factors remaining the same, causes the output of the good using the accumulating factor intensively to increase and the output of the other good to decrease in absolute amount, provided that commodity and factor prices remain unchanged. Suppose in a country supply of labor increases. This will lead to increase of products involving intensive usage of labor like clothes. On the other hand it will reduce the output of capital intensive products like steel.

An influx of labor does not lower wages, but it does cause both labor and capital to flow out of the capital-intensive sector and into the labor-intensive sector. Labor-intensive production will rise but capital-intensive production will fall. This implies that following immigration the capital-intensive production should fall, following an exogenous influx of labor, wages remaining constant or nearly constant.