3.2 Costs and economies of scale

• Fixed Costs

  Costs that remain constant as output changes e.g. rent or mortgage repayments.
• Variable Costs

  Costs that change as output changes e.g. raw materials
• Total Costs

  The sum of fixed and variable costs
• Average cost

  Total costs/output
• Marginal costs

  The extra cost of producing one more unit of output
• Short run (in terms of fixed and variable factors)

  The period of time during which at least one of a firm’s factors of production is fixed
• Long-run

  The time period in which all inputs can be varied
• The law of diminishing returns

  When additional units of a variable input are added to fixed inputs after a certain point, the marginal product of the variable input declines.
• Internal economies of scale

  The cost reductions enjoyed by a single business as it grows
• Reasons for internal economies of scale - link to Q rising faster than TC

  1)Financial - negotiate lower interest rates with banks due to reputation

  2)Marketing - bulk buy advertisement and negotiate a lower unit price spread costs

  3)Technical - Specialist machinery boosts productivity

  4)Management - employ managers and boost productivity

  5)Purchasing - firms are able to buy in bulk and spread costs over a wider range of products
• External economies of scale

  The cost reductions avaliable to all businesses as the industry grows
• Reasons for external economies of scale link to TC falling

  1. Concentration of businesses
  2. Infrastructure
  3. Technology and skills
• Diseconomies of scale

  The situation in which a firm’s long run average costs rise as firm increases output
• Reasons for diseconomies of scale - link to TC rising faster than Q

  1. Control - drift for managers to control workforce bc of size and productivity falls
  2. Communication problems - can't spread messages about efficient ways quickly enough so productivity falls
  3. Coordination (poor) and decision - making sure everyones is working the same
  4. Motivation of the workforce - individuals feel less values and motivation falls decreasing productivity
• Minimum efficient scale

  The lowest rate of output at which a firm takes full advantage of economies of scale.
• The extent to which a business benefits from or is limited by economies and diseconomies of scales depends upon:

  1. Demand for the product or service
  2. The nature of production
  3. Technological advancement
  4. The importance of price
  5. The nature of the product or service
• Diagram to illustrate economies & diseconomies of scale

  A) Average Cost

  B) Output

  C) Economies of Scale

  D) Diseconomies of scale

  
• Returns to Scale

  This is how the output of a business responds to a change in all factor inputs. These can be increasing, decreasing or constant.
• Divorce of ownership from control:

  This may lead to conflict between the board of directors and shareholders for example, as different stakeholders may have different objectives.