3.3.3 Economies and Diseconomies of Scale

What do lower costs over a range of output represent?

an improvement in productive efficiency and can give a business a competitive advantage in a market. They can also lead to lower prices and higher profits

What can dis-economies of scale lead to?

Diseconomies of scale leads to rising long-run average costs LRAC rises due to firms expanding beyond their optimum scale Diseconomies are difficult to identify precisely

Definition of Dis-economies of Scale

An Increase in LRAC when the firms changes factors of production to increase output - decreasing returns to scale

What does the LrAC Falling mean?

As long as the long run average total cost curve (LRAC) is declining, then internal economies of scale are being exploited by a business.

Problems with dis-economies of scale

Control and communication problems occur as a firm increases in size Loss of identity - workers and managers lose their sense of belonging and loyalty as a firm grows and so they work less hard/efficiently

Explanation for the LRAC and SRAC curves

The whole LRAC curve is made up of infinite points where it just touches (tangent to) SRAC curves, representing the lowest possible average cost for each unit of output when all inputs are variable.

what is important to remember about long the long run about costs

in the long-run, all factors of production are variable. This means that IN THE LONG RUN ALL COSTS ARE VARIABLE Land and capital are usually fixed in the short run as they are more difficult to change quickly.

Economies of Scale-Internal vs External What is external economies of scale?

the falling average costs of production shown by a downward shift in the average cost curve which as firm can gain as a result of the growth of the industry within the firm operates normally associated with a particular area Supply of skilled labour Reputation Local knowledge and skills Infrastructure Training facilities

why is the law of diminishing returns very important in determining the shape of the cost curves

Increasing marginal returns: Extra output produced by an extra unit of labour rises This means the the additional cost of producing n additional unit (MC) falls Decreasing marginal returns And additional output of each unit of labour is falling Therefore the additional cost of each unit (MC) increases

Where do economies of scale arise from?

Increasing returns to scale

Where do economies of scale arise from?

Increasing returns to scale in the long run

Returns to scale definiton

Economies of Scale - LRAC decrease as output increases Constant Returns to Scale - LRAC are constant as output increases Diseconomies of Scale - LRAC increase as output increases

How do economies of scale and large scale firms relate?

Economies of scale are the advantages of large scale production that result in lower unit (average) costs (cost per unit) AC = TC / Q

What is internal economies of scale?

Economies of scale that arise because of the growth of the scale of production within a firm Internal economies of scale are firm-specific, or caused internally, while external economies of scale occur based on larger changes outside of the firm. Both types result in declining marginal costs of production, yet the net effect is the same

More internal economies of scale efficiency of capital equipment indivisibility of capital equipment indivisibility of plant Agriculture

Efficiency of capital equipment-Larger machines sometimes more efficient than smaller ones somethings firms with a small value of output cannot make effective use of large machines so it is forced to use smaller less efficient ones Indivisibility of capital equipment-Machines only available in large sizes that require volume cannot be divided into smaller pieces of equipment. Indivisibility of plant Not viable to produce products like oil, chemicals on small scale - need large amounts of capital Agriculture - machinery appropriate for large scale work - combines etc,

Sources of economies of scale Managerial economies

Employing specialist staff is likely to lead to greater efficiency and therefore lower cost

Side by side internal/External economies of scale

Expansion of the firm itself/Expansion of the industry of which the firm is a member

What does the minimum efficient scale reveal?

It can reveal important info on the nature of the industry: Will the industry have a few large firms? Or will the industry have many small firms? If Economies of Scale for firms in an industry end at relatively small quantities (i.e. MES occurs quickly)....the industry will likely many smaller firms. If Economies of Scale for firms in an industry exist over large quantities (i.e. MES occurs at high quantities)....the industry will likely have a few large-sized firms.

More scale economies-learning economies

Learning Economies Efficiencies due to the length of experience in a market Readily available in high-knowledge industries "Learning by doing" "Tricks of the trade"

Eval-Potential Limits to Economies of Scale

Limited total market demand for many products Market demand may be insufficient for businesses to fully exploit the scale economies "Niche markets" allow smaller-scale producers to supply at higher cost because consumers are willing to pay a higher price Falling demand in a recession - capital will be under-utilised leading to excess capacity and rising average total costs Occupational immobility of capital equipment Some large units of fixed capital may not be transferable to other uses if there is a sudden switch in consumer demand. Diseconomies of scale A business may expand beyond the optimal size in the long run and experience diseconomies of scale

What are some examples of internal economies of scale

Specialised managers are more efficient Division of Labour - small activities performed more efficiently Bulk buying - negotiate larger discounts Financial economies - large firms raise capital (or get loans) more cheaply (considered less risky) Transport economies - charged less for delivery of large orders Spreading costs over larger volumes of output eg research and development costs Technical economies i.e. containerization in shipping and tourism Risk-bearing economies arise from product diversification Network economies - networks of suppliers / customers - low marginal cost of adding users

What can cause shifts in lrac curve?

Taxation Tax upon the industry=costs rising e.g-if the government increased employers National Insurance contribution- a tax upon the wage bill of a company the total cost of labour will rise pushing up average costs

More internal economies of scale Technical-law of increased dimensions

Technical Economies of Scale The Law of Increased Dimensions Cubic law can be applied where cubic volume increases more than proportionate to surface area Economies of linked processes Production processes can linked together with one integrated plant - important in mass production which requires complex manufacturing processes Large-scale indivisible units of capital machinery Capable of high productivity (e.g. presses used in the manufacture of steel products) Huge units of capital require a vast output in order to reduce the average cost per unit Specialisation and Division of Labour

What is the LRAC also known as and why ?

The LRAC curve is also known as the "envelope" curve because it envelops all SRAC curves

Why is the LRAC curve a U shape?

The U-shape of the LRAC is due to Economies of Scale and Diseconomies of Scale...

What are dis-economies caused by?

They are often caused by the complex nature of managing large-scale firms and in managing the growth of a business (1) Costs of administration and coordination of the workforce (2) The growth of corporate bureaucracy (i.e. which might be seen in excessive layers of management) (3) The risk of worker alienation or shirking because of the problems in monitoring the effectiveness of workers (4) Differences in the optimum scale of units of capital (5) An increase in transportation costs to distant markets Diseconomies can lead to a misallocation of scarce resources if firms do not achieve long run productive efficiency-Market failure

examples of external economies of scale Research transport networks influx of human capital agglomeration economies

University Research Departments helping to fun research Transport Networks lower logistics costs Relocation of Suppliers to the centre of production Influx of human capital - highly skilled workers Agglomeration economies are important. Businesses in similar industries tend to cluster together and attract an influx of skilled talent which then provides human capital to expanding businesses. -e.g Silicone valley

What is Economies of Scale?

When increasing output by a firm results in lower AVERAGE TOTAL costs in the long run (where a firm is able to increase all input factors

Constant returns to scale?

When the % change in output = % change in inputs E.g when a 10% increase in all factor inputs leads to a 10% rise in total output Long run average total cost will be constant

What are increasing returns to scale

When the % change in output is greater than the % change in inputs E.g. a 30% rise in factor inputs leads to a 50% rise in output Long run average total cost will be falling

Decreasing returns to scale?

When the % change in output is less than the % change in inputs E.g when a 60% rise in factor inputs raises output by only 20% Long run average total cost will be rising

Economies of scale more examples

Where it is cheaper to produce a range of products than to produce each individual product on its own McDonalds hamburgers and french fries share the use of food storage and preparation facilities Proctor & Gamble P&G owns over 250 brands, including Pringles crisps, Crest toothpaste, Max Factor make up and Pampers nappies Graphic designers and marketing experts can use their skills across hundreds of product lines Car manufacturers Car panels / interiors are common to a range of models Airlines If an airline has a hub and spoke network then adding one more route to its network creates many more potential transfer routes for the airlines customers

Pneumonic for economies of scale

really fun mums try making pie Really- Risk-When a firm becomes larger, they can expand their production range. Therefore, they can spread the cost of uncertainty. If one part is not successful, they have other parts to fall back on. Fun-Financial: Banks are willing to lend loans more cheaply to larger firms, because they are deemed less risky. Therefore, larger firms can take advantage of cheaper credit Mums-Managerial: Larger firms are more able to specialise and divide their labour. They can employ specialist managers and supervisors, which lowers average costs. Try-Technological: Larger firms can afford to invest in more advanced and productive machinery and capital, which will lower their average costs. Making-Marketing: Larger firms can divide their marketing budgets across larger outputs, so the average cost of advertising per unit is less than that of a smaller firm. Pie-Purchasing: Larger firms can bulk-buy, which means each unit will cost them less. For example, supermarkets have more buying power from farmers than corner shops, so they can negotiate better deals.

What about the U shape of the SRAC curve?

the U-shape of SRAC curves is due to diminishing marginal returns. Diminishing marginal productivity is only for the SHORT RUN

Minimum efficient scale/Plant size(see difference one says of an individual plant within the industry)

the point at which the increase in the scale of production yields no significant unit cost benefits. the point where increasing the scale of production of an individual plant within the industry yields no significant unit cost benefits. Long story short Increasing output does not result in lower average cost it yields no cost benefits as its just before diseconomies of scale