The Gains from Trade with Variable
Costs
So far, we have assumed that opportunity costs are the same whatever the
scale of output, and we have seen that there are gains from specialization
and trade as long as there are differences in opportunity costs across
countries. If costs vary with the level of output, or as experience is
acquired via specialization, additional gains are possible.
Economies of Scale
In many industries, production costs fall as the scale of output increases.
The larger the scale of operations, the more efficiently large-scale
machinery can be used and the more a detailed division of tasks among
workers is possible. Small countries (such as Switzerland, Belgium, and
Israel) whose domestic markets are not large enough to exploit
economies of scale would find it prohibitively expensive to become self-
sufficient by producing a little bit of everything at very high cost.
One of the important lessons learned from patterns of world trade since
the Second World War has concerned scale economies and product
differentiation. Virtually all of today’s manufactured consumer goods are
produced in a vast array of differentiated product lines. In most
industries, any one firm produces only one or a few of the different
versions of the product. It does this because it is producing for a larger