Theoretical Aspects of International Trade

Economies of Scale

The size and cost of supplied goods are of great importance in international trade. In its turn, it primarily depends upon economies of scale. By economies of scale economists mean factors which cause the average cost of producing a commodity to fall as output of the commodity rises. For instance, a firm or industry which would less than double its costs, if it doubled its output, enjoys economies of scale.

There are two types of such economies. The first — called internal — accrue to the individual firm regardless of the size of its industry. They generally result from technological factors which ensure the optimal size of production is large: (a) With high fixed costs in plant and machinery, the larger its production, the lower the cost per unit of the fixed inputs. For example, producing steel without a blast furnace is possible but very expensive; once a blast furnace is built, it is inefficient only to make small quantities of steel with it: hence, steel companies tend to be large, (b) Large firms can also arrange for the specialization of labor and machines — as in the techniques of the production line which can increase productivity. (Smith, A.) (c) Only large firms can afford the high costs of research and development. Non-technological factors are important too, however. For example, by buying inputs in bulk, large firms can get discounts from their suppliers (who grant them because of economies of scale in distributing the supplies). There are also economies of scale in business finance.

The second type — external economies — arise because the development of an industry can lead to the development of ancillary services of benefit to all firms: a labor force skilled in the crafts of the industry; a components industry equipped to supply precisely the right parts; or a trade magazine in which all firms can advertise cheaply. These can at least partially explain the much observed tendency for firms to cluster geographically more often than would be predicted from random location decisions. The existence of economies of scale in most industries is used to explain the predominance of large firm s in the world economy, but recently there has been some reassessment of the relative importance of technological economies of scale as such.

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Theoretical Aspects of International Trade

The essence of the principle put forward by Heckscher- Ohlin is that a country will export those commodities that are intensive (capital-intensive; labor-intensive) in the factor in which it is most well-endowed. The law of comparative advantage (Ricardo, D.) had been established by economists as an explanation for the existence and pattern of international trade based on the relative opportunity- cost advantages between different countries producing different commodities.

Due to Heckscher—Ohlin principle opportunity cost acquires particular importance. By it we understand the value of that which must be given up to acquire or achieve something. Economists attempt to take a comprehensive view of the cost of an activity. If a firm invests undistributed profits to spend £1,000 on new machinery which requires less electricity to run than the equipment it replaces, the cost of that machinery is not the outlay of £1,000 alone: what could be earned from the best alternative use of the money also has to be taken into account. If, for example, the firm is paying 12 per cent interest on an overdraft and the saving in electricity is less than £120 a year, it would be better for the firm to pay off its overdraft than to invest in the new machinery. If a self-employed person makes a profit of £8,000 a year but pays himself no wage, he needs to consider the alternative use to which his time could be put. He might, for example, be able to earn £10,000 a year working for someone else: this is the opportunity cost of his time. Accounting costs, as in these examples, normally allow only for cash outlays, but cash outlays will only approximate to opportunity costs where competition ensures that the prices of all factors of production are equal to those for their best alternative use (Wieser, F. von). (Under the assumptions of perfect competition, the self-employed person would be aware that he could earn more in employment and, since we assume profit maximization, he would do so.) Economists also distinguish between private costs and social costs and costs in real terms and money terms.

However, the economists interpreted the law of D. Ricardo in different ways. The law says nothing about why or how a comparative advantage exists. The Heckscher—Ohlin principle states that advantage arises from the different relative factor endowments of the countries trading. The principle was first put forward by Eli F. Heckscher (1879—1952) in an article published in 1919 and reprinted in Readings in the Theory of International Trade (1949). It was refined by Ohlin in his Interregional and International Trade (1933). The principle has been developed further.

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