Increasing returns to scale

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Explain the increasing returns to scale as a basis for international trade. Be sure that you define the relevant concepts, describe important features of such trade, and contrast these features with those of trade due to other causes.

While international trade has been present throughout much of history, its economic, social, and political importance have been on the rise in recent centuries, mainly because of industrialization, advanced transportation, globalization, multinational corporations, and outsourcing.

Let us discuss the concept of increasing returns to scale.
Increasing returns to scale leads to decreasing marginal opportunity cost Average and Marginal cost decreases as output increases in the long run. Economists usually explain "increasing returns to scale" by indivisibility. For example some methods of production can only work on a large scale -- either because they require large-scale machinery, they require a great deal of division of labor. Since these large-scale methods cannot be divided up to produce small amounts of output, it is necessary to use less productive methods to produce the smaller amounts. Thus, costs increase less than in proportion to output -- and average costs decline as output increases. Positive changes in average and marginal productivity reduce the cost of production. This is because of improvement in the marginal productivity and average productivity leads to economies of scale which helps in the cost reduction. On the other hand the "law" of diminishing marginal returns says that after a possible initial increase in marginal returns, the Marginal product of an input will fall as the total amount of the input rises (holding all other inputs constant). Thus diminishing marginal returns imply increase in marginal cost. This is shown in the downward sloping part of MPL curve. This is often explained as due to congestion. For example, consider a wheat farm: as the farm employs more and more workers, the farm will start ...