Managerial Economics - Chapter 7 - Economies of Scale and Scope

Learning curves describe a relationship between

average variable cost and the cumulative number of units produced.

The long-run average cost curve exhibits diseconomies of scale?

between 40 and 50 units per hour.

Increasing complexity of management and challenges of coordination as firms produce a wider variety of products can be a source of

diseconomies of scope.

If a firm doubles its inputs and output more than doubles, its production process exhibits

economies of scale.

If economies of scope exist across two products, we would expect that firms will likely ________.

produce and sell both products

Diseconomies of scale imply that

the firm should consider a reduction in production.

Constant returns to scale means that as all inputs are increased,

total output increases in the same proportion as do the inputs.

The figure below shows a long-run average cost curve. What part of the long-run average cost curve exhibits economies of scale? IMAGE: https://prnt.sc/pkaejk

Between 10 and 20 units per hour

Which of the following helps explain why marginal cost eventually increases as output increases?

The law of diminishing returns

Economies of scope exist when

changing the mix of products produced reduces average cost.

Between 20 and 40 units per hour, the long-run average cost curve exhibits?

constant returns to scale.

Increasing complexity of management and challenges of coordination as firms produce more of the same product can be a source of

diseconomies of scale.

The variety of Riverside Ranger logo T-shirts includes 12 different designs. Setup between designs takes one hour (and $23,000), and, after setting up, you can produce 1,000 units of a particular design per hour (at a cost of $12,000). Note: Assume Q denotes the quantity produced of a particular design. *PART 2: Based on this information, production in any one single design _____ economies of scale.*

exhibits

Suppose you have a production technology that can be characterized by a learning curve. Every time you increase production by one unit, your marginal cost decreases by $4. There are no fixed costs, and the first unit costs you $70 to produce. Use the given information to fill in the marginal cost of each unit, as well as the total cost and average cost of each level of output. Suppose you receive a request for proposal (RFP) on a project for *four*units. Your break-even price for *four* units is $____. Suppose that if you get the contract, you estimate that you can win another project for two more units. The break-even price for those next two units alone is $____.

*Q/MC/TC/AC* *1 / $70 / $70 / $70* *2 / $66 / $136 / $68* *3 / $62 / $198 / $66* *4 / $58 / $256 / $64* *5 / $54 / $310 / $62* *6 / $50 / $360 / $60* Marginal Costs: 70-4=66 66-4=62 62-4=58 .... etc. Total Costs: 70+66=136 66+136=198 62+198=256 ... etc. Average costs: 136/2=68 198/3=66 256/4=64 ... etc. *Break Even-Price for 4 units: $64.00* 70-4=66 70+66+62+58=256 66-4=62 256/4= 64 62-4=58 *Break even for next 2 units: $54.00* 58-4=54 54-4=50 ---- =104 / 2 = 54_

Suppose Nike's managers were considering expanding into producing sports beverages. *Why might the company decide to do this under the Nike brand name?*

*The cost of producing sports beverages along with its current products under the Nike brand name is less than the cost of producing sports beverages under a new brand name plus the cost of producing Nike's current products under the Nike brand name.* Economies of scope exist between two products when the cost of producing both products jointly is less than the cost of producing the two products separately. Mathematically, this can be stated as: Cost(Q1 , Q2) < Cost(Q1)+Cost(Q2) where Q1 and Q2 are two products. In this case, Nike may choose to produce sports beverages under the Nike brand name to take advantage of economies of scope. That is, it may be cheaper to produce both sports beverages and shoes along with Nike's other current products under the same brand name than to produce sports beverages separately under a new brand name. Mathematically, if CostNike is the cost of producing under the Nike brand name and CostNew is the cost function for producing products under a new brand, then economies of scope would imply that: *CostNike(Current Products, Sports Beverages)<CostNike(Current Products)+CostNew(Sports Beverages) * Stated differently, the cost of producing current products under the Nike brand name and sports beverages under a new brand name is greater than the cost of producing both products under the Nike brand name.

The variety of Riverside Ranger logo T-shirts includes 12 different designs. Setup between designs takes one hour (and $23,000), and, after setting up, you can produce 1,000 units of a particular design per hour (at a cost of $12,000). Note: Assume Q denotes the quantity produced of a particular design. *PART 1: Which of the following best represents the average cost function for producing any single design?*

AC=($23,000/Q) + $12

Use the table to indicate which description characterizes economies of scale and which characterizes economies of scope. *Long-run average costs are lower for greater quantities of output.*

Economies of Scale Economies of scale, also sometimes called increasing returns to scale, occur when the long-run average costs of producing a specific good fall as output increases. In other words, the long-run average costs of producing a specific good are higher at smaller quantities of output and lower at larger quantities of output. Mathematically, if the long-run average total cost function is denoted LRATC , then economies of scale imply that LRATC(Qa) < LRATC(Qb) when Qa > Qb (where Qa and Qb represent distinct quantities of the same good).

Use the table to indicate which description characterizes economies of scale and which characterizes economies of scope. *The cost of producing two products separately is greater than the cost of producing both of those goods jointly.*

Economies of Scope Economies of scope occur when the cost of producing two products jointly is less than the cost of producing them separately. Conversely, economies of scope imply that the cost of producing the two products separately is greater than the cost of producing them jointly, and such cost savings are a major motivation for mergers. Mathematically, if Cost(Q) represents the cost function for producing output Q , then economies of scope imply that Cost(Q1,Q2) < Cost(Q1)+Cost(Q2) (where Q1 and Q2 represent quantities of two separate goods).

The below table reports the costs of producing Products A and B separately last year. IMAGE: https://prnt.sc/pkafai Here is a table of projected costs of producing the two products together in the coming year. Is there any evidence of economies of scope in producing these two products together? If so, which cost indicates this? IMAGE: https://prnt.sc/pkafhp

Product B marketing cost

Calculate per-unit costs and compare to last year. Are the reduced unit costs for Product A due to scale or scope? IMAGE: https://prnt.sc/pkafw1

We cannot be certain whether the reduced per unit costs for product A are due to scale or scope.

The below table describes the productivity of workers at a sub shop (say during a 10 minute period). # of workers / Sand. produced 1 / 2 2 / 5 3 / 9 4/ 12 5 / 14 At what point does marginal productivity begin to decline?

With the fourth worker

The law of diminishing marginal returns refers to the general tendency for __________to eventually diminish.

marginal productivity

Under constant returns to scale, average cost _____ as the quantity produced increases. Over this range of output, the marginal cost curve is _____ the average cost curve.

remains constant; equivalent to