Economies of scale

conditions of demand and supply - supply depends, in the long run, on whether average costs of production fall or rise as the firm's scale of operations increases

Profit depends on what?

prices

technology: if firms are able to reduce costs, they may also be able to reduce what?

- markets - threaten

technology: tech can create ............ and also .......... industries

new and better products and processes leading to innovative products and provide more choice for customers

technology: technology can lead to the development of what? (benefit for consumers)

- refer to sheet

Draw a diagram showing external diseconomies of scale

higher long-run average production costs resulting from the growth of the industry of which the firm is a part

Internal and external diseconomies of scale: Define external diseconomies of scale

profit

Microeconomic theory generally assumes that a firm seeks to grow in order to enable more ....... to be made

- occurs when long-run average costs fall as a result of operating more than one plant

Define 'Multi-plant economies of scale'

refers to lowering the average cost for a firm in producing two or more products. (economies of scale = reductions in average costs resulting from increasing the scale of production for a single product type)

Define economies of scope

Lower long-run average production costs resulting from the growth of the industry of which the firm is a part

Define external economies of scale

- relates to the bulk buying or bulk borrowing of funds required to finance the business's expansion - large firms can often borrow from banks and other financial institutions at a lower rate of interest and on better terms than those available to small firms

Define financial or capital-raising economies of scale

- Arises from the firm itself being large rather than from operating a single big plant or a number of large sites - Associated with the growth of the enterprise

Define firm-level economies of scale

Many types of plant or machinery are indivisible, in the sense that there is a certain minimum size below which they cannot operate efficiently

Define indivisibilities

Lower long-run average production costs resulting from an increase in the size or scale of the firm in the long run

Define internal economies of scale

The two types of marketing economies are bulk buying and bulk marketing economies

Define marketing economies

- large firms are usually less exposed to risk than small firms because risk can be grouped and spread - a bank can predict with some confidence the number of customers who will turn out to be bad debtors, but it is unlikely to know in advance which customers will be - risks are therefore spread and uncertainty is reduced because the bank knows that for each bad debt there will be many other solvent customers whose business is profitable

Define risk-bearing economies of scale

Increasing returns to scale means that a plant size increases, a firm combines its inputs in a technically more efficient way. Technical affects the size of the typical plant or establishment rather than the overall size of the firm, which may own and control several different plant sizes.

Define technical economies of scale

1. Whether the process of consolidation in the industry has resulted in an industry structure consistent with the least-cost production of water services in England and Wales 2. Whether the evidence on economies of scale presents a case for further horizontal integration in the industry 2. Whether there are opportunities for a more efficient industry structure through different types of restructuring

Does size matter? Economies and diseconomies of scale in the water industry: In January 2004, Ofwat, the government's regulatory agency for the water and sewage disposal industries, published a report entitled 'investigation into evidence for economies of scale in the water and sewerage industry in England and Wales'. The objective of the study was to provide answers to which three questions?

concluded that there were significant diseconomies of scale for water and sewerage companies - there were likely to be constant returns to scale for the water-only companies

Does size matter? Economies and diseconomies of scale in the water industry: What did the report conclude?

Water is a localised industry - water is heavy and expensive to move around therefore having utilities based around urban areas is likely to be an efficient means of operating the sector - optimal size will be determined by the characteristics of these urban areas

Does size matter? Economies and diseconomies of scale in the water industry: Why are the findings of the study not surprising?

- refer to sheet

Draw a diagram showing external economies of scale

- refer to sheet

Draw a diagram showing internal economies of scale and internal diseconomies of scale

Internal and external

Economies of scale is divided into what?

the operation of a number of identical machines in a larger plant means that proportionately fewer spare parts need to be kept than when fewer machines are involved - this is an application of the law of large numbers, since we can assume that not all machines will develop a fault at the same time

Explain economies of massed resources

- Much manufacturing activity involves a large number of vertically related tasks and processes, from the initial purchase of raw materials, components and energy, through to the completion and sale of the finished product - Within a single firm, these processes may be integrated through the links between the various plants owned by the firm - the linking of processes in a single plant can lead to a saving in time, transport costs and energy

Explain economies of vertically linked processes

- Can be achieved both by increasing the size of an individual plant or, at the level of the firm, by grouping a large number of establishments under one management - both methods of expansion allow for increased managerial specialisation and the division of labour - this involves the delegation of detail to junior managers and supervisors and a functional division of labour, namely the employment of specialist managers (e.g. production, personnel and sales)

Explain managerial economies of scale

with large plants, research and development costs can be spread over a much larger production run, reducing unit costs in the long run

Explain the spreading of r&d and development costs

- known as economies of increased dimensions - with many types of capital equipment (metal smelters, transport containers, storage tanks, warehouses) costs increase less rapidly than capacity - when a storage tank or boiler is doubled in dimension, its storage capacity actually increases eightfold- therefore becoming, technically, more efficient, than a small one - volume economies are thus very important in industries such as transport, storage and warehousing, as well as in metal and chemical industries

Explain volume economies

1. economies of agglomeration e.g. if a firm is based in a particular area with other firms in the same industry, they can share resources e.g. r&d and specialist supplier firms may set up, supplying goods more cheaply 2. If the suppliers grow larger, they may benefit from internal economies of scale. This will lead to cheaper inputs for a firm and reduce costs. This may be caused by growth in the industry as a whole, which leads to more orders for suppliers so they can expand.

External economies of scale occurs when the cost per unit at every level of output is reduced because of factors within the industry but outside the firm, such as ............

decision making ability to respond to customer's needs or to problems arising in the course of production - As a result, the resources the business uses are not allocated effectively as they could be - top management loses touch with junior managers and employees and with the problems facing the business

Internal and external diseconomies of scale: (managerial) in the situation of communication failure, what suffers? What is the result?

- negative cluster effect - when the close proximity of firms increases the cost of negative externalities such as road congestion and pollution, which each firm dumps on its market co-members. - Close geographical proximity can lead to labour shortages caused by industry firms competing for labour and higher resulting wage costs

Internal and external diseconomies of scale: A firm may suffer from what effect? Give an example

Higher long-run average production costs resulting from an increase in the size or scale of the firm in the long run

Internal and external diseconomies of scale: Define internal diseconomies of scale

- result from communication failure (occurs when there are many layers of management between the top managers and ordinary production workers)

Internal and external diseconomies of scale: Managerial diseconomies can result from what?

- manufacturing - tertiary (provision of financial services)

Internal and external diseconomies of scale: Name a few industries which grow large in order to benefit from the falling long-run production costs brought about by economies of scale

- economies of scale refers to a fall in the cost per unit - increasing returns to scale refers to changes in output - increasing returns to scale contributes to economies of scale but one measures costs, the other output

Internal and external diseconomies of scale: What is the main difference between returns to scale and economies of scale

managerial diseconomies

Internal and external diseconomies of scale: What is the most significant type of internal diseconomy of scale?

Occur when a firm's long-run average costs of production increase, not because of the growth of the firm itself, but because of the growth of the industry or market of which the firm is a part

Internal and external diseconomies of scale: When do external diseconomies of scale occur?

by decentralizing so that people lower down in the organisation are involved in decisions and by ensuring that communication is good

Internal and external diseconomies of scale:How may internal diseconomies of scale be overcome?

the plant sites they operate

Internal economies of scale: Sometimes firms grow larger but what does not generally grow significantly in size?

- occurs when managers learn from experience how to operate particular technologies and methods of production more effectively - learning effects are usually associated with a change in the scale of a firm's operations, but they can also occur as a result of the reorganisation of existing capacity

What are 'learning effects'?

- Technical economies of scale - sometimes management economies

What are the main plant-level economies of scale?

- Marketing economies - Financial or capital-raising economies of scale - Risk-bearing economies of scale

What are the main types of firm-level economies of scale?

- Indivisibilities - spreading of R&D costs - volume economies - economies of massed resources - economies of vertically linked processes

What are the main types of technical economy of scale? (5)

when unit production costs fall because of the growth of the scale of the whole industry or market, rather than from the growth of the firm itself

When does a firm benefit from external economies of scale?

large

When technical economies of scale are great, the typical plant or establishment is also ........... in size

- poor communications - low morale; employees may feel alienated as the company grows and the gap between the 'top' and the 'bottom' grows - lack of control

Why might internal diseconomies of scale occur?

involves the use of science and engineering to innovate and develop tools, equipment and pocesses to undertake wok more effectively or more efficiently

technology: Define

A firm can set up a website and trade globally fairly and cheaply

technology: Technology can make it easier to enter a market, give an example

encourage other firms to innovate to gain their own control over a market

technology: What impact can patents have on other firms?

the market for CDs has changed following the growth of MP3 players and downloading

technology: give an example of how technology can upset markets

help them gain control of a market

technology: how can innovation help firms?

via patents

technology: how can new inventions be legally protected?

fee - provides monopoly power for a given period of time

technology: if a business registers a patent, competitors cannot use this idea unless it is licensed to them for a ....., what does this provide a business?

affecting demand and/or reduce costs affecting supply

technology: technological developments can add value to products, affecting what?