Long-Run Costs

• 6 reasons for the existences of internal economies of scale:

  • Risk-bearing economies of scale
  • Managerial economies of scale
  • Financial economies of scale
  • Purchasing economies of scale
  • Technical economies of scale
  • Marketing economies of scale

  (Richard's Mum Flies Past The Moon)
• Risk-bearing economies of scale - Occurs where large profitable firms are able to use their profits to diversify and enter different markets. The cost of failure is relatively small due to the profitable parts of the business. On the other hand, small businesses without large profit margins are unable to diversify and enter a variety of markets. As a result, small firms rarely diversify meaning that the cost of failure in that market will be high
• Managerial economies of scale - Occurs when a firm is able to employ specialist managers to improve the productivity of workers in a business. This improvement in productivity will increase output more than total costs thus reducing average costs
• Financial economies of scale - Occurs when large firms are able to negotiate lower rates of interest on loans for investment projects. This is because large firms have a track history of success and are therefore less risky to lend money to. Lower interest rates reduce the unit cost of production
• Purchasing economies of scale - Occurs when a firm is able to purchase raw materials and component parts in bulk and thus negotiate a large discount per unit. This leads to a reduction in the unit cost of production
• Technical economies of scale - Occurs when a firm grows in size and are able to purchase highly specialist machinery to enhance their production. As a consequence, the productivity of capital increases where output rises faster than total costs reducing average costs and the unit cost of production
• Marketing economies of scale - Occurs when a large firm are able to use their size and dominance in the market to negotiate bulk deals and discounts when marketing. Consequently, total costs are rising but more slowly than output, reducing the unit costs of production
• Internal diseconomies of scale:

  • Alienation
  • Bureaucracy
  • Communication
• Alienation occurs as a business becomes larger resulting in workers feeling alienated and a less significant part of the workforce, this can demotivate workers and reduce productivity
• Bureaucracy occurs when large businesses have many layers of management therefore coordination becomes difficult therefore an unnecessary amount of paperwork is required
• Communication issues occur when a business is so large that managers find it difficult to monitor their staff
• The Long-Run Average Cost Curve:

  
• External economies of scale occurs outside a firm but within an industry. When an industry expands, there are likely to be benefits for the firm
• Returns to scale is the increase or decrease of outputs depending on inputs
• Increasing returns to scale: % Change in outputs > % Change in inputs
• Decreasing returns to scale: % Change in outputs > % Change in inputs
• Constant returns to scale: % Change in outputs = % Change in inputs