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External Economies of Scale

Internal Economies of scale normally refers to the idea that larger firms are more efficient
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Reasons for External Economies
The three main reasons for External Economies of scale are as follows:
1
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o Specialised companies can achieve a greater level of economies of scale than a firm
that manufactures all components in house (Lower costs)
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o Circular Causality brings about concentration of industry
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2
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o Therefore, industries may want to locate closer to skilled workers, reducing hiring costs
and worker search time
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Knowledge Spill overs
o Similar firms often share ideas and working methods
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o Therefore, firms locate close to each other to acquire ideas from personnel
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 China has a lower average cost than the USA
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 Both countries are supplying their domestic industries
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Therefore:
 The US industry contracts
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Until all production is in China
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RECAP

In Ricardian Model and H&O, prices converge, however with external economies, prices are reduced
everywhere
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Consider Thailand and Switzerland producing watches
Production may not be in the ideal
location all the time
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 2<1
 Ideally Thailand would
supply the market
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Infant Industry Argument

The main argument for this is that temporary protection of industries enables them to gain
experience, however this often isn’t temporary and becomes permanent
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Because Brazil is at point 2, there is no incentive to start producing, they can’t get into the market
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Short run costs, long run benefits
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Failure of Infant Industry Policy
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Politicians do not have information of foreign costs
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Local producers will lobby government to keep protectionist measures indefinitely

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