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Economies of Scale

Sometimes a particular product requires such huge investment in machinery and in developing a skilled labor force that the resulting output can be sold at a low enough price to be competitive only when some enormous amount of output is produced, because of what economists call “economies of scale.” If General Motors produced only a hundred Chevrolets, the cost per car would be astronomical, since all the expensive machinery and all the engineering research and development that went into creating the automobile would have to be recovered from the sale of just 100 vehicles. It has been estimated that the minimum output of automobiles needed to achieve an efficient cost per car is somewhere between 200,00 to 400,000 automobiles per year. Producing in such huge quantities is not a serious problem in a country of the size and wealth of the United States. But, in a country with a much smaller population—Australia, for example—there is no way to sell enough cars within the country to be able to develop and produce automobiles from scratch to sell at prices that would compete with automobiles produced in much larger quantities overseas. If you take small countries like South Korea and Taiwan, they have to depend on international trade to be able to produce on a scale far exceeding what can be sold domestically. International trade is necessary for many countries to achieve economies of scale that will enable them to sell at competitive prices. For some products requiring huge investments in machinery and research, only a very few large and prosperous countries could reach the levels of output needed to repay all these costs from domestic sales alone. International trade creates greater efficiency by allowing more economies of scale, as well as by taking advantage of each country’s absolute or comparative advantages.
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