Given production possibilities for a firm use trade theory t

Given production possibilities for a firm, use trade theory to determine when outsourcing of value creating activities would be justified.

Solution

Trade theory is a collection of various economic models in International Trade. The key focus of trade theory is on the increasing returns to scale and the network effect that makes it possible. Trade theory has been in compliance with the various trade restrictions that are in place in specific countries. Trade theory typically focusses on the returns to scale. Hence when a firm explores the production possibilities it will only try to reduce costs and increase profits. If there is comparative advantage for its products then it will try to purchase the same but the entire activity seems to be profitable when outsourced then the company will be forced to take a firm decision in order to keep the company running.

For instance many banks in US outsource their call centre activities to third world countries due to the availability of cheap labor. According to trade theory, the companies should plan and explore their production possibilites where there are increased returns to scale or investment. So when the companies have big difference in the productions costs and the increased profits by outsourcing, the outsourcing of value creating activities are justified.