ECONOMIES OF SCALE
AND
COMPARATIVE ADVANTAGE
Jana Štefaňáková & Maroš Ciran
To determine the pattern of international trade we have to think about
how economies of scale interact with comparative advantage.
 imagine a world consisting of Home and Foreign country
 each country has two factors of production: capital and labor
Home – capital abundant country
Foreign – labor abundant country
 there are also two industries:
Manufactures (more capital – intensive industry)
Food (labor intensive)
Interindustry Trade (manufactures for food)
• Home (capital abundant) will
produce more manufactures
(capital intensive) they will
export manufactures and
import food
• Foreign country will act
contrary (export food and
import manufactures)
 in a world without economies of scale, there would
be a simple exchange of manufactures for food
Intraindustry Trade (manufactures for manufactures)
• suppose that manufactures
don´t produce homogenous
products (monopolistically
competitive industry = firm now
produce differentiated products)
• Home country will still be net
exporter of manufactures and
importer of food but some
Home consumers will prefer
Foreign varieties
Four points about this pattern of trade:
1. Interindustry trade reflects comparative advantage (Home, capital
abundant country, is a net exporter of capital-intensive
manufactures)
2. Intraindustry doesn´t reflect comparative advantage. It is
economies of scale that keep each country from producing the full
range of products
3. The pattern of intraindustry trade is unpredictable. We don´t know
which country produce which goods within the manufacture sector.
All we know is that countries produce different products.
Four points about this pattern of trade (cont.)
4. The relative importance of intraindustry and interindustry trade
depends how similar countries are (measured by capital-labor ratio).
 Home and Foreign with similar capital-labor ratio =
little interindustry trade and dominant intraindustry trade
 Home and Foreign with very different capital-labor ratio =
no intraindustry, all trade based on interindustry trade
The Significance of Intraindustry Trade
• About one-fourth of world trade is Intraindustry trade
(according to the standard industrial classifications)
• It plays a particular role in the trade of manufactured goods
among advanced industrial countries
The major trading industrial countries have become similar in their levels
of technology and resources (skilled labor and capital) therefore, there
is often no clear comparative advantage within an industry
The Importance of Intraindustry Trade (I)
• I = 0, if a country is either exporter
or importer (not both) in an
industry = interindustry trade
• I = 1, if a country´s exports equal
its imports within an industry =
intraindustry trade
• Industries with high levels of Intraindustry trade tend to be
sophisticated manufactured goods (such as chemicals,
pharmaceuticals, power-generating equipment)
• exported by advanced nations
• Industries with very little Intraindustry trade are usually laborintensive products (such as footwear and clothing)
• exported by less developed countries
Why Intraindustry Trade Matters?
• Intraindustry trade produces extra gains from
international trade
it allows countries to benefit from
larger markets
Consumers benefit from increased variety of goods
Country can reduce the number of varieties produced and increase
its productivity with lower costs it can produce each product at
larger scale
When the Intraindustry Trade is most likely to happen?
• It is most common between countries at a similar level of
economic development – similar in their capital-labor ratios,
skill levels and so on
• Gains from Intraindustry trade will be large when economies
of scale are strong and products are highly differentiated
Example: Establishment of a free trade area in manufactured goods in
Western Europe in 1957 (EEC) – the result was a rapid growth of trade
(twice as fast as the whole world trade in the 1960s)
Case Study - Intraindustry Trade in Action
American Auto Pact of 1964
• Before 1964 – a tariff protection on auto industry
goods between Canada and U.S.
Very self-sufficient industry – neither importing nor exporting a lot
Canadian industry controlled by the same firms as the U.S. industry – a
miniature version of the U.S. industry
small scale production was a
big disadvantage for Canadian subsidiaries
Labor productivity in the Canadian auto industry about 30% lower than of
the U.S.
Case Study - Intraindustry Trade in Action (cont.)
American Auto Pact of 1964
• In 1964 – establishment of a free trade area in
automobiles between Canada and U.S.
 it allowed auto companies to reorganize their production
 thanks to importing the products no longer made in Canada and
exporting the goods Canada continued to make
overall level
of Canadian production and employment remained the same
Both exports and imports increased sharply
By the early 1970s – productivity of Canadian industry
comparable to the U.S. productivity
Thank you for your
attention!