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Chapter 7
External Economies of Scale
and the International Location
of Production
◼ Chapter Organization
Economies of Scale and International Trade: An Overview
Economies of Scale and Market Structure
The Theory of External Economies
Specialized Suppliers
Labor Market Pooling
Knowledge Spillovers
External Economies and Market Equilibrium
External Economies and International Trade
External Economies, Output, and Prices
External Economies and the Pattern of Trade
Box: Holding the World Together
Trade and Welfare with External Economies
Dynamic Increasing Returns
Interregional Trade and Economic Geography
Box: Tinseltown Economics
Summary
◼ Chapter Overview
In previous chapters, trade between nations was motivated by their differences in factor productivity or
relative factor endowments. The type of trade that occurred, for example of food for manufactures, is
based on comparative advantage and is called interindustry trade. This chapter introduces trade based on
economies of scale in production. Such trade in similar productions is called intraindustry trade and
describes, for example, the trading of one type of manufactured good for another type of manufactured
good. It is shown that trade can occur when there are no technological or endowment differences but when
there are economies of scale or increasing returns in production, as opposed to the constant returns to scale
assumed in previous chapters.
Economies of scale can either take the form of (1) external economies, whereby the cost per unit depends
on the size of the industry but not necessarily on the size of the firm; or as (2) internal economies, whereby
© 2015 Pearson Education, Inc.
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
6. The three forces driving external economies of scale are access to specialized suppliers, labor market
7. Even with higher wages in China, the external economies of scale industries located in China may not
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
9. a. External economies of scale are likely due to the need to have a common pool of labor with
© 2015 Pearson Education, Inc.
