3.3.3 Economies and diseconomies of scale

What happens with the LRAC with internal economies of scale? What happens with the LRAC with external economies of scale?

Internal EOS: movement along LRAC (rightwards) External EOS: shift of LRAC (downwards). E.g government invests in road infrastructure

What are sources of diseconomies of scale?

Bureaucracy - Firms become too bureaucratic, slower process in big companies, too many forms etc Principle agent problem - The larger the company the more likely the principal-agent problem. Miscommunication between the manager and the agent Communication problem - Information may not be communicated quickly enough in a large firm.It can be hard to communicate ideas and new working practices. Lower the morale of workers and reduce productivity Demotivation - unproductive, high rates of absenteeism. Easier as difficult for managers to notice. Working in a highly specialised assembly line can be very boring if workers become de-motivated. In a large firm, there is an increased gap between top and bottom e.g. call centres

What are sources of external economies of scale?

Commercial services - marketing agencies, lawyers, insurers. They may relocate to areas/clusters of companies. Efficient as companies will no longer have to spend money on travelling to these services. University programmes - E.g universities creating courses tailored for specific industries. University programmes established by Unis in order to train their students to get into specific jobs. These companies therefore don't need to train these employees as much Infrastructure - Government has an incentive to help thriving industries in specific areas as it will cause an increase in GDP. The government will provide infrastructure, roads etc, reducing these companies' travel times. (Firms operating in the same industry might gather together in the same location (e.g. car industry: Detroit or start-ups: Silicon Valley) The provision of suitable labour and skills e.g the midlands, where car factories are located, there are sufficiently skilled workers

What is economies of scale

Economies of scale occur when something increases in size and the average cost fall

What is minimum efficient scale

Minimum efficient scale occurs when a firm is productively efficient

What are sources of internal economies of scale?

Purchasing - economies of scale achieved via buying in bulk. Larger businesses have the cash and output to warrant buying materials in much larger quantities, which can brings their per-unit cost down. Smaller businesses are unable to achieve. E.g Ikea and furniture shop Marketing - An advantage of large firms, which have a lower unit cost for advertising and promotion than small firms E.g large hotel companies vs one off hotels Financial - larger businesses are seen by lenders as more reliable or worthy of credit due to their size. Better interest rates on borrowing in comparison to smaller businesses Managerial - occur when large firms can afford specialists. They more effectively manage particular areas of the company Risk bearing (or economies of scope) - allows a firm to spread risk by having a number of different products to fall back on. If there is a reduction in demand for one, it is easier to make cost savings by reducing production of that item. As the firm has other products they can continue to sell. E.g Mars, dog food, rice - Technical, improved production methods that reduce average costs. Large firms can purchase efficient capital equipment with high fixed costs

What are external diseconomies of scale

The external economies of scale can occur if there are excessive businesses in a particular area. This causes all factors of production which firms buy to increase, rent cost rise, wages cost rise, too greater competition pushing up the cost of all factors of production. E.g london rents due to the high competition for office space, causes an external diseconomies of scale. It further can cause high levels of congestion

Explain increasing returns to scale and decreasing returns to scale on a diagram

When companies grow, average costs fall - There is a point where minimum average costs is met, they are productivity efficient. The best point one can be - Some however, merge too far and may see their average costs increase. They are experiencing diseconomies of scales. Increasing returns to scale When the %increase in inputs<%increase in output AC decreases (EOS Constant returns to scale When the %increase in inputs=%increase in output AC remains constant Decreasing returns to scale When the %increase in inputs>%increase in output AC increases (DOS)

What is diseconomies of scale?

When firms increase in size and their average costs increase

What is external economies of scale?

lower AC as the whole industry grows

What is internal economies of scale

lower AC due to the firm expanding itself