Preference Similarity Theory: The hypothesis that is developed by Swedish economist Linder in 1961 deals with the trade of non-homogenous industrial goods. According to this view the trade of goods depends not on the production costs but on the similarity of taste and preferences, that is to say on demand conditions. The basic factor that determines the taste and preferences is relative income level.
According to Linder, firms in a country produce the goods that are demanded by the majority of public and have a large market. As firms produce in order to cover domestic demand they get experience and efficiency in the production of that good; later on these goods are exported to the countries that have similar taste and preferences or more broadly to the countries that have close income levels. On the other hand the demand of low or high income individuals who have different taste and preferences are supplied with importation from the countries that have similar taste with them. According to this view which is also known as “Over-lapping demands” the trade of industrial goods will be intensive among those countries that have similar preferences and income levels.
The Linder’s theory has not been supported much because it can not explain the trade of industrial goods that do not have domestic market or in other words that are produced only for export.
Theory of Economies of Scale: In some goods average production cost depends on the scale or volume of the production. If average costs decrease with the scale of production, there is decreasing costs and increasing returns to scale.
In the factor endowment theory the assumption of constant returns to scale prevails. In case of increasing returns because of economies of scale, profitable trade arises even when both parties are identical in every aspect. This is another type of trade that Heckscher-Ohlin theory can not explain.
Economies of scale, besides the cost advantage of large enterprises over small ones, cause the formation of imperfect competition.
