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1. Cases a and d reflect external economies of scale since concentration of the production of an
industry in a few locations reduces the industry’s costs even when the scale of operation of
individual firms remains small. External economies need not lead to imperfect competition. The
2. This view is flawed in the sense that countries produce more than one good. Trade allows a country to
There may be a case made for external economies leading to losses from trade, however. Consider
the diagram above. Country A is an established producer and produces at quantity QA and price PA. If
country B were to enter into the industry, its initial startup cost would be at CB. Since this is greater
3. Dynamic increasing returns occur whenever average costs fall with cumulative output. In other words,
there exists a learning curve that favors established producers over startups. This is an open-ended
question, though the examples in Question 9 provide some ideas. Two industries characterized by
experience with one model may be a huge help in creating a new one. 4. a. The relatively
b. Since economies of scale are significant in airplane production, it tends to be done by a small
c. Since external economies of scale are significant in semiconductor production, semiconductor
d. “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
e. France has a particular blend of climactic conditions and land that is difficult to reproduce
5. a. Both countries have identical forward-falling supply curves, so the pattern of production will
depend entirely on which country establishes its industry first. The country that moves first will
b. Both countries benefit from international trade in this case as the price of the good will be lower
when one country produces the entire output as compared to both countries producing half of the
6. 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
7. Even with higher wages in China, the external economies of scale industries located in China may
not move to lower-wage countries. Consider Figure 7-4 in the text. China’s average cost curve lies
above Vietnam’s reflecting higher wages in China. However, the fact that Chinese industry is
8. 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
9. a. External economies of scale are likely due to the need to have a common pool of labor with
b. External economies are unlikely since it is difficult to see how the costs of a single firm would
c. External economies are highly likely because having a great number of support firms and an
d. External economies are somewhat likely in that it may be advantageous to have other
e. External economies are somewhat likely if there are a set of skills unique to the timber industry
