As mentioned in Chapter 1, international trade occurs because of a number of reasons. The theories of comparative advantage, factor endowments, economies of scale, and product life cycle have been advanced as four major motives for international trade. 1
The theory of comparative advantage assumes that all countries will improve economically if each specializes in production of the good that it can produce more efficiently and buys other goods from a country that can produce more efficiently, assuming a comparative advantage exists between the countries.
The theory of increasing returns is a relatively new theory used to explain why international trade occurs. Increasing returns is shorthand for increasing returns to scale, which is synonymous with economies of scale. The theory holds that trade arises to take advantage of economies of scale. Companies in a country can gain lower unit costs by producing large volume and spreading start-up costs. By producing for both domestic and foreign markets, volume can be increased and costs can be reduced. 2