3.2- costs and economies of scale

• Long run

  The length of time when all factors are variable
• Short run


  The length of time when at least one factor of production is fixed
• Total cost (TC)


  The cost to produce a given level of output
• Total fixed cost (TFC)


  Costs which do not vary with output
• Total variable costs

  Costs which change with output
• Average cost/average total cost (AC/ATC)?


  The cost of production per unit
• Sunk costs

  Costs that can’t be recovered
• Law of diminishing returns

  If a variable factor is increased when another factor is fixed, there will come a point where each extra unit of the variable factor will produce less extra output than the previous unit; after a certain point, marginal output falls
• Internal economies of scale

  An advantage that a firm is able to enjoy because of growth in the firm, independent of anything happening to other firms or the industry in general.
• External economies of scale

  An advantage which arises from the growth of the industry within which the firm operates, independent of the firm itself.
• Economies of scale

  The advantages of large scale production that enable a large business to produce at a lower average cost than a smaller business
• Diseconomies of scale

  The disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise.
• Increasing returns to scale

  An increase in inputs by a certain proportion will lead to an increase in output by a larger proportion.
• Decreasing returns to scale

  An increase in inputs by a certain proportion will lead to output increasing by a smaller proportion.
• Constant returns to scale

  Output increases by the same proportion that the inputs increase by.
• Minimum efficient scale

  The lowest level of output necessary to fully exploit economies of scale.
• Average cost = total cost / output
• Marginal cost = change in total cost / change in output
• Average fixed cost = Total fixed costs / output
• Average Variable cost = Total variable cost / output
• Diminishing returns

  Decreasing productivity or output as more resources are added.

  When MC starts to rise as MP falls
• Fixed costs?


  Costs that remain constant as output changes

  For example, rent, worker salaries or mortgage repayments
• Variable costs?

  Costs that change as output changes

  For example, cost of raw materials or workers wages
• What are total costs?

  The sum of fixed costs and variable costs.
• What is marginal cost?

  The extra cost of producing one more unit of output
• What is the 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
• What is the long-run in terms of fixed and variable factors?

  The time period in which all inputs can be varied
• What is the law of diminishing returns?


  The law of diminishing returns states that as more units of a variable input are added to a fixed input, the marginal product of the variable input will eventually decrease.
• Law of diminishing returns diagram

  
• What are internal economies of scale?

  The cost reductions enjoyed by a single business as it grows
• Reasons for internal economies of scale


  Purchasing, technical, marketing, management and financial
• What are external economies of scale?

  Cost reductions available to all businesses in an industry as it grows
• Reasons for external economies of scale?


  Concentration of businesses, infrastructure, technology and skills
• What are diseconomies of scale?

  Increased costs per unit of production as a company grows in size.
• Reasons for diseconomies of scale?

  Communication, motivation and coordination
• What is the minimum efficient scale?

  The lowest rate of output at which a firm takes full advantage of economies of scale
• Diagram showing economies and diseconomies of scale

  
• The extent to which a business benefits from or is limited by economies and diseconomies of scale depends upon:

  • Demand for the product or service
  • The nature of production
  • Technological advancement
  • The importance of price
• Short run


  Period of time in which at least one factor of production is fixed
• The long run


  A period of time in which all inputs can be varied