1. Distinguish between external and internal economies of scale and use these concepts to explain the phenomenon of intra- industry trade. Can the Heckscher-Ohlin model of trade explain intra-industry trade? Explain.

Economies of scale are very important concept to explain the relationship between scale of production and cost of per unit. They consist of external economies of scale and internal economies of scale. According to standard definitions, external economies of scale arise when the cost of per unit production decreases as the size of overall industry increases, but not necessarily on the size of an individual firm changes. Internal economies of scale arise when the cost of per unit production decreases as the size of an individual firm increases, but not necessarily on the size of the whole industry changes (Lawler & Seddighi, 2001).

External economies of scale                              Internal economies of scale

Cost per unit                                          Cost per unit








Size of industry                                Size of one individual firm

Usually, the external economies of scale are associated with the cluster of firms located in a specific district.  Marshall argued that there are three main reasons to explain why the firms in industrial district are more efficiently than isolation firm. They are specialized suppliers, labour market pooling and knowledge spillovers (Krugman, et al., 2011). The specialized suppliers mean that the key inputs of production are more easily and much cheaper accessed by firms in that specific district. The labour market pooling means the more specific skills of workers are available to cluster of firms so that minimizing the search and hiring cost of labours. The knowledge spillovers could be demonstrated that employees from different firms could communicate with each other in many causal places due to the short geographic distance among them, as a result, many new ideas could made up by discussions and communications.

Unlike the external economies of scale, the internal economies of scale are based on firm’s own characteristics, such as marginal cost of product, product differentiations. In fact, the valid of internal economies of scale is not consistent with the pure competition market assumption, since under that assumption, all firms are price takers and only have ability to affect their output but not the price level. But the internal economies of scale mean that firm is capable to decrease its cost per unit through expanding production and also decreased its price level in order to attract more consumers.  In fact, to make guarantee of internal economies of scale, it is necessary to assume the market is in imperfect competition. Under this scenario, there are either few major producers in market or still many firms but produce differentiated products from each other.


Based on the theory of internal economies of scale, it is possible for countries to produce the similar kinds of tradable products and services and achieve transactions among each other. However, even they are similar kinds of products and services, but it is necessary to stress that they are not the same products, customers could identify the differences among each other on many aspects.  For producers, it is good for them to sell more products under the economies of scale so that generate more revenues as well as profits. In detail, the external economies of scale encourage them to build plants in a specific district so that enjoy benefits from specified suppliers, labour pooling market and knowledge spillovers. At the same time, the internal economies of scale drive them to produce the differentiated products even though for the same commercial or personal purposes so that capture market as much as possible.  Under this two kind of economies of scale, which play significant roles in driving the intra industry trade. It is reasonable to believe that customers enjoy great benefits due to intra industry trade because they would have range of similar products and services choices from domestic and overseas producers at a lower price.


However, the intra industry trade cannot be explained by Heckscher-Ohlin model.

The reason is that the logical of the H-O model depends on some important assumptions, among which, at least two of them are inconsistent with the theory of economies of scale. The first is perfect competition exists in all kinds of market, the second is the production functions exhibit constant returns to scale in the long run (Lawler & Seddighi, 2001). The H-O model predicts that each country will export goods that produced with relatively abundant factors of endowments and import goods which used with relatively scared factors of endowments (Lawler & Seddighi, 2001). In other words, the H-O model asserts that comparative advantage which arises by the differences of initial endowments (e.g. physical or human capital accumulation, natural resources) of different counties are main conditions to trade. However, the intra industry trade is not based on comparative advantage of different countries, but the economies of scale, either external or internal term. Two countries with similar initial endowments and productivity could still be able to trade between each other in similar kinds of tradable goods and services, one typical example is trade between Germany and France. They are all industrial countries and the knowledge/ technical factors did not make any significant differences.  The reason why the trade happened is that these two industrial counties are next to each other and firms in countries make use of economies of scale fully so that they could produce as much as possible and offer the lowest price to customers as they can. To sum up, the H-O model ignores the market structure or individual firm’s operating activity in micro level, but only considered the big picture of international trade and comparative advantage of different countries, which resulted in the ignorance of intra industry trade phenomenon.







  1. Examine the extent and pattern of   intra-industry trade within the Eurozone trading area. What are the implications of your analysis for trade creation within this trading zone? Explain with direct reference to your analysis of relevantevidence and data.


In order to examine the extent of intra industry trade within the Euro zone trading area, it is necessary to introduce the index of intra industry, which could refer it as T.

According to definition from the text book, T= 1- |(X-M)/ (X+M)|, where X represents the total amount of exported goods for one country in a particular industry, M represents the total amount of imported goods for one country in the same industry. In fact, if there is no intra industry trade, which means that all trade is inter industry type, then, every country only specialized in produce goods that cannot be produced by others. As a result, every country cannot produce (export) and import the same kind of tradable goods or services, so that trade among industries of different countries flows in only one direction. In detail, when country A exports goods X, it definitely cannot import goods X. So the trade flow is one way and the index of intra industry is zero.  If there is total intra industry trade, which means every country could produce the similar kinds of tradable goods or services and exchange for each other, in other words,  X=M, so T=1.

Therefore, for a particular industry, T is located between one and zero. The greater the index, the bigger level of intra industry trade in that particular industry.


Based on discussions above, it is clear to know how to measure the extent of intra industry. By extracting data from Eurostat Pocketbooks, one report about External and intra-European Union trade from 2002 to 2007, it is possible to calculate the level of particular intra industries trade in different countries. For simplify reasons, just put all main industries into two categories, one is primary products, the other is manufactured goods.  In fact, the manufactured goods are the mainly exported item for European Unions. They usually take up about 85% of total EU exports. Among which, machinery and vehicles weighted up 44% total exports, while other manufactured products accounted for 25%.  Chemicals industry contributed for 16% of total exports.  In terms of primary products, which only account for 12% of total exports. Among which, food and beverage industry is the most important contributor, which took 5% of total exports (eurostat, 2009).


For imports, the size of primary products imported grew fast, which increased the share from 27% in 2002 to 34% in 2007, while the share of manufactured products decreased from about 70% in 2002 to around 64% in 2007. As the report mentioned,    the main reason behind this could be thanks to the growth demand of imported energy products. Even though, manufactured goods were still the most important imported components.  Among which, machinery and vehicles industry took the largest share of total imported goods, which was 30%.  Chemical products with other manufactured goods took the greater shares of total imports than machinery and vehicles.

As a consequence, the manufactured products which include chemicals industry and machinery and vehicles industry are the most important industries that use to measure the extent of intra industry to specific countries.

Intra industry trade index for some European countries 2007



Manufactured goods


Machinery and vehicles






































(All data above are through calculation from primary data source, eurostat, 2009)


The table above shows the extent of manufactured products intra industry for some European countries. From above, it is clear to see all countries listed except for Greece were in highly extent of intra industry trade on manufactured goods in 2007. It is known that Germany, Britain, France and Italy are not only the most industrial countries in the Europe, but also took up top four economy bodies by their sizes (IMF, 2010). The GDP per capita for all those countries was above $35,000 (World Bank, 2009).  In addition, all those countries above produce vehicles, machinery equipment and the closer geographic connections ensure the lowest transportation cost among those countries. In detail, France enjoys the largest intra industry index on manufactured goods, especially for machinery and vehicles, which is close to unity. As we know, France itself produces many vehicles and machinery equipment, while, Germany also provides many vehicle and machinery choices to France customers. It is reasonable to believe that France exported large amount of vehicles and equipments to the world as well as imported nearly same amount of vehicles and equipments from overseas, especially from neighbour countries such as Britain, Germany, which mainly produce high end and luxury vehicles and also Italy, which usually provides cheaper vehicles and very small amount of super cars. The situation of Italy is roughly the same as France, even though the extent of intra industry trade is less than France. For reasons why the index of Germany and UK are much lower than France, it could explain that Germany is famous for its high quality machinery and vehicles equipments, the trade flow for those products might not keep the same as in France, partly because Germany provides much more products to the US and new emerging counties, such as BRIC, and the other reason is that Germany customers might not prefer the other countries’ brands even though in same quality.


For Greece, which experienced the lowest level of intra industry trade in 2007. The reason is due to many factors.  It is necessary to know that economy structure of Greece is not based on manufacturing vehicles, machinery equipments, but shipping and tourism. Of particular, it needs to consider that the size of Greek economy only took the 16th among all European countries, which only accounts for about 9% of Germany size. As a result, it is hard for Greek exporters to compete with peers from Western European countries in producing the similar kinds of products and equipments. This is one of the most important reasons that the intra industry level for Greece in manufactured goods is very low compared to other listed countries above.


By definition from text book (Lawler & Seddighi, 2001), trade creation is the replacement of expensive production that used to be in domestic by cheaper imports from member countries under a custom union.


Germany trade balance from 2002 to 2007


(Eurostat, 2009)

The diagram above illustrates the trade balance of Germany from 2002 to 2007, which consists of intra- EU trade and Extra- EU trade.  From the graph, it is clear to see that Germany is becoming more dependent on intra EU trade other than extra-EU trade. In 2002, the Intra- EU trade balance was 72.2 billion EUR and the extra-EU trade balance was only 11.6 billion EUR less than Intra trade balance. But in 2007, the gap between intra trade and extra trade was 58.9 billion EUR, which was over five times compared to the situation in 2002. In addition, the intra trade balance was always increasing from 2002 to 2007 and the average annual growth rate was about 15%. However, the extra EU trade was not kept increasing, from 2002 to 2003 and from 2004 to 2005, which presented trade balance decreasing.  The annual growth rate was only about 2.3 % in the same period.  Of particular, it is necessary to know Germany is one of the most important and powerful country in Europe, which contributed nearly 20% of European total GDP in 2007(IMF, 2007).  The increasing of Germany’s intra EU trade balance means that the Germany exports industry is beneficial from the European economic integration and generates substantial revenues from neighbour countries other than long distance partners such as the US and China. To other European countries, the increasing intra trade balance of Germany means that the European Union and especially for European Euro made critical contributions for them to import relatively cheaper products from Germany and did not build expensive plants or produce the same products but more costs by themselves any more.


France trade balance from 2002 to 2007


The diagram above reflects the trade balance of France from 2002 to 2007. The scenario of France is definitely opposite with Germany’s.  The negative trade balance means the France imported much more goods and services than they exported. The total trade balance decreased dramatically from 2002 to 2007.  Of particular, the intra EU trade made dominant contribution to the overall trade deficit, which took 98.4% of total trade balance. However, the extra EU trade created positive trade balance to France, even the figure was decreasing dramatically from 13.1billion EUR in 2002 to no more than 1 billion EUR in 2007. Still consider that France is the second largest economy in the Europe area, which took about 15% of total Europe GDP( IMF,2007).

It is undisputable that intra trade balance weights up the nearly all trade balance of France. The experiences of France demonstrate that for many reasons, France is becoming more and more dependent on intra trade within European Union and it might be most likely that France imports many relatively cheaper products from neighbour countries, such as Germany or Italy.  Recall that the intra industry trade index for France is the most biggest one from table above,  which means that France exported many goods and imported many similar kinds of products, the trade deficit could be explained that the price differences of those goods. One obvious example is the France vehicle manufacturers exported Renault or Peugeot to her neighbour countries such as Germany or Britain, but rich French usually purchase imported luxury vehicles like BMW or Jaguar from Germany or Britain. Even though, France could enjoy the relatively cheaper imported products thanks to the establishment of custom union.


Greece trade balance from 2002 to 2007


As a small economy, Greece experienced dual trade deficits from intra EU trade and extra EU trade from 2002 to 2007. Even though, the intra trade deficit was greater than extra trade deficit. As discussed before, the extent of intra industry trade for Greece was the lowest from table above, it had to import many manufactured products from overseas, which cannot produce by herself. The intra industry trade balance was substantially greater than extra trade balance reflects that Greece is beneficial from importing relatively cheaper products from European member countries, which is the typical case of trade creation.




















  1. Explain what you understand by “an optimum currency area”. Is Euro-zone an optimal currency area? Discuss with reference to the key theoretical and empirical indicators including your analysis of the extent and pattern of intra-industry trade within the Euro-zone trading area in (b), and an analysis of the extent of labour mobility in Euro-zone area. What are the implications of the theoretical predictions and empirical evidence concerning the future of the Euro as a single currency? Discuss.                                           


The optimum currency area could be explained that in a geographic area, which often beyond one particular country’s border, countries located in that area employ a single currency to maximize the efficiency of economic activity and minimize the transaction cost due to difference currency used and eliminate the exchange rate volatility. Of particular, the monetary authority is withdrawn from individual nation, instead, one single administration body would be responsible for monetary policy. In fact, the optimum currency area is the most important condition for that regional economic integration and fully makes use of the economies of scale in that region.  Once all member countries in that specific area use same currency, it also means the commencement of political integration, which could minimize the violent conflicts among these countries and form a solid political and economic power in the world.  In addition, under the same currency area, it provides more opportunities for firms to enlarge their markets since the transaction activities could be more efficiently and barriers to trade could be eliminated as much as possible.  It would result that customers in that optimum currency region enjoy the more choices of products as well as lower price thanks to economies of scale. Produces could decrease their product price and different producers might do integrations with each other or build the industry clusters in some specific areas.  To sum up, the optimum currency area could bring substantial political/economic benefits to member countries and producers as well as customers.







From many respects, Euro- zone could be regarded as optimum currency area. In the first place, the European Central Bank is responsible for Euro, which means the monetary authority is not belonged to any sovereigns any more but a single institution to make monetary policy  (http://www.ecb.int/ecb/html/index.en.html).

Then, the optimum currency area would enhance the economic integration within that area. From discussions in part b, the extent of intra industry trade is very large for main European economies. Take trade balance into consideration, which also reflects the cross border trade activities happened within the European union are much greater than with outside trade partners. Specifically, Germany and France, which accounts for largest and second largest economy in the Europe respectively, represents for two typical scenarios. One is the export oriented, the other is import oriented, both of which enlarged the trade volume substantially from 2002 to 2007. In fact, the consequence is largely due to the intra trade activity and the increasing level of intra industry trade reflects the increasing extent of economic integrations within Europe union.  One report released by European Central Bank (2006) examined the increased labour mobility within the EU 25 and did cost and benefit analysis for immigrants’ home country and their destination countries.  Through the systematically analysis, it concluded that the potential migrants flow are most likely to keep at moderate level. In detail, it predicted that potential migrant flow could be from 1% to 4% of total  population of new members’ in one or two decades. In fact, the main direction of labour flow is from Central and East Europe countries, which the wage rate is different from the figure in EU-15 significantly. However, the labour flow from new member countries is restraint by socio economic/demographic changed, as that report admitted,  once new member counties are able to catch up economically with EU- 15 ( Original European countries),  there is less incentive for people in new member countries cross border to find another job opportunities. Further, the aging problem also happened in new member countries so that the potential migrants are limited in the medium to long term. Even thought, the report pointed out a serious problem that labour is not able to move freely in European Union, especially for new member countries, there are substantially amount of barriers (e.g. working permit limitations, social culture differences) for their young and skilled workers to entry the western European labour market.  In addition, the European Commission (2001) concluded that EU citizens only have half mobility rate of US citizens, in the last ten years, there was only 4.4% of EU citizens moved to another member state. It is reasonable to believe that the inertia of culture could become one of the most important factors to limit large scale immigrations even thought there was recently enlargement of EU.



As the first single currency among many member countries, the perspective of Euro is discussed by many scholars and politicians, especially for the current European Sovereign debt crisis. Many people believed that Euro area would be collapsed soon, others proposed to establish a new and small Euro area, which only consists of highly credibility countries.  However, as the report from Reuters (2011), the president of European Central Bank, Mario Draghi argued that Euro as one currency is irreversible. He held a cautious optimistic and believed the Europe area economic activity would recover from crisis gradually. This assignment also discussed the extent of intra trade and labour mobility of Europe, the conclusion is consistent with Mr. Draghi since Euro is an optimum currency in large extent, the intra trade is highly developed among member countries and reflects the highly level of economic integration. Further, the labour mobility among different counties could maximize the efficiently use of capital and increase the regional income as much as possible. If the Euro collapsed, which could produce uncountable damages to the integration of Euro area and many firms or consumers cannot enjoy the benefits that arise from economies of scale and intra industry trade. Of particular, if some counties start to use their own currency but not Euro as common currency, the exchange rate risk would become another barrier to cross border trade activities.


As a conclusion, as one single currency, Euro might be stable in foreseeable future. The worst scenario might be come out when some countries’ fiscal disciplines are too worse to solve out under the current Euro framework. If in that case, it is possible for European countries to restructure their debts and form a new currency area and to coordinate the monetary policy and fiscal policy so that ensure a stable and risk controllable currency area.




Lawler, K. & Seddighi, H. International Economics: Theories, Themes and Debates, Pearson Education, 2001.


Krugman, P.R., Obstfeld, M., Melitz, M.J. International Economics: Theory and Policy (9th) Pearson Education, 2011.


Eurostat, Pocketbooks, External and intra-European Union trade, Data 2002-07


International Monetary Fund, World Economic Outlook database, 2007


World Bank, World Development Indicators database, 2009


The European Central Bank, retrieved from http://www.ecb.int/





Sectoral specialization in the EU: a macroeconomic perspective MPC task force of the ESCB, July 2004.


Reuters, 2011, retrieved from http://www.reuters.com/

原文链接:International trade