Question

This question deals with external economies of scale. a) How does external economies of scale potentially justify infant industry protection? Use a diagram to help you answer this. b) Suppose that Germany and India can both produce shirts, but India has a lower average cost curve. Germany has the head start in world production of shirts, beginning as the world’s only supplier of shirts. Even though Germany has the head start advantage, India can still enter production of shirts. Draw the AC curves and world demand curve of this scenario, making sure to label the initial world price and quantity produced, as well as each AC curve.

Answer 1

a) External economies of scale imply that as the size of an industry grows larger or more clustered, the average costs of doing business within the industry fall. This may occur due to increased specialization or training of workers, faster innovation or shared supplier relationships.

The infant industry argument is an economic rationale for tradeprotectionism. The core of the argument is that nascent industriesoften do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar economies of scale.