Increasing Returns and Comparative Advantage

Abstract

* The author would like to thank the Bureau of Business and Economic Research of Georgia State University for the time made available to finish this paper. Also, he would like to thank Professor Charles P. Kindleberger for his comments on an earlier draft as well as a reviewer of the Southern Economic Journal for his comments. 'As Professor Chipman [2] observed, Edward West stated as early as 1815 of the great classical laws, well-grounded empirically in the observed tendency in the eighteenth and nineteenth centuries for manufactures to fall in price relative to foodstuffs,... to the effect agriculture was characterized by diminishing returns, and manufacturing by increasing returns. 2See references: [1], [2], [3], [4], [9], [10]. 8Thus, Professor J. E. Meade assumes either the economies of scale are external to the individual firms and there is a system of taxes and subsidies which equates price to marginal social cost in each competitive industry, or the economies of scale are internal to large monopolistic firms and the State controls each industry in such a way it produces up to the point at which the price is equal to the marginal social cost of [8, 33]. On the other hand, Murray C. Kemp [5, 111] makes the assumption that all external economies to the firm are...of equal severity in both industries, in the sense the ratio of marginal private cost to marginal social cost is the same in both industries. Essentially the same assumption is also made by R. C. O. Matthews [7]. It the purpose of the present paper to develop an admittedly simple model incorporating i creasing returns in a rigorous fashion. The assumption the marginal rate of transformation (MRT) reflects relative prices will be dropped. Therefore, the analysis of increasing returns will have to be different from of constant returns whether the PPF is convex or concave.4 Let us first look at a closed economy consisting of two industries which use a single homogeneous primary factor of p oduction, called labor-existing at a fix d quantity (L) inelastically suppliedand produce commodities Q, and Q2 respectively. The two industries are respectively subject to constant returns and increasing returns due to external economies,5 a necessary assumption for the existence of pure competition. Finally, assume the production of one unit of Q1 requires exactly one unit of labor.