4.5

• economies of scale definition

  As output increases, long-run average cots fall
• diseconomies of scale definition

  as output increases, long-run average cost rises
• what are internal economies of scale and diseconomies of scale?

  changes in long-run average costs of production resulting from changes in the size or scale of a firm or plant
• what are internal economies of scale?

  cost saving that come from within the firm as it grows - these shift the LRAC curve downwards
• external economy of scale definition

  a fall in long-run average costs of production resulting from the growth of the market or industry of which the firm is a part
• external diseconomy of scale definition

  an increase in long-run average costs of production resulting from growth of the market or industry of which the firm is a part
• what is the mnemonic for remembering examples of internal economies of scale?

  Really Fun Mums Try Making Pies

  • risk bearing
  • financial
  • managerial
  • technological
  • marketing
  • purchasing
• What are the types of internal economies of scale?

  • risk-bearing - can spread risk across products/markets
  • financial - big firms borrow at lower interest
  • Managerial - specialist managers = better decisions
  • Technological - bigger machines = more efficiency
  • marketing - adverting costs spread over more units
  • Purchasing - bulk buying = discounts
• what are external economies of scale?

  cost savings that come from outside the firm, due to the growth of the industry or area e.g skilled local workers, shared suppliers, imported transport
• what is the minimum efficient scale (MES)?

  the lowest level of output at which a firm achieves productive efficiency (lowest possible average cost) - bottom of the LRAC curve
• what are diseconomies of scale?

  when a firm gets too big and costs per unit start rising due to inefficiencies
• causes of internal diseconomies of scale?

  • communication problems - information gets lost in big teams
  • coordination issues - hard to organise large operations
  • motivation drops - workers feel less values in a huge firm
• Diagram - LRAC curve with economies and diseconomies of scale

  • a U-shaped curve:
  • Left side: economies of scale - LRAC falls
  • Bottom: MES
  • Right side: diseconomies of scale - LRAC rises
• why are economies of scale important in competitive markets ?

  they let firms lower prices, increase profit or investment in innovation - huge competitive advantage
• how can small firms survive despite not achieving economies of scale?

  • niche markets
  • customer loyalty
  • personalised service
  • government support or subsidies
• what are external diseconomies of scale?

  These occur when the entire industry grows too large, causing rising costs for all firms, not just one
• examples of external diseconomies of scale?

  • congestion = delivery delays
  • rising wages = increased competition for labour
  • overuse of shared infrastructure = breakdowns
• how do external diseconomies of scale shift the LRAC curve?

  they shift the entire LRAC curve upward, meaning firms face higher costs at every level of output, even if they haven’t changed anything internally
• what is the relationship between returns to scale and economies/diseconomies of scale?

  • increasing returns to scale leads to falling long run average costs or economies of scale
  • decreasing returns to scale bring about rising long-run average costs or diseconomies of scale
• why might increasing returns to scale not lead to economies of scale?

  because if input costs rise at the same time (e.g wage inflation, higher rent), cost per unit might still go up, even if output increases faster
• what is the link between economies/diseconomies of scale and LRAC?

  • economies of scale = falling LRAC
  • diseconomies of scale = rising LRAC
  • the LRAC curve is U-shaped because of this relationship
  • bottom of the U = minimum efficiency scale (MES) - most efficient size of firm
• what are long-run marginal costs (LRMC)?

  the change in long-run total cost when output increases by one more unit, all inputs are variable
• what is the formula for long-run marginal costs?

  $LRMC\ =$$\frac{\Delta LRTC}{\Delta Q}$
• how do LRMC and LRAC curves relate?

  • when LRMC < LRAC, LRAC is falling - economies of scale
  • when LRMC > LRAC, LRAC is rising - diseconomies of scale
  • LRMC = LRAC, LRAC is at its minimum point (MES)
• how do firms use LRAC and LRMC to make decisions?

  firms compare marginal costs to average costs and revenue. if LRMC is rising above LRAC, it may not be worth expanding. helps decide optimal scale of production and whether to grow or stay lean