3.3.3 economies and diseconomies of scale

• SRAC u-shaped due to the law of diminishing returns

  LRAC u-shaped due to economies and diseconomies of scale

  
• economies of scale in the long run

  in LR all costs are assumed to be variable - scale of production can be changed

  economies of scale are the unit cost advantages from expanding the scale of production in the long run - lower costs represent an improvement in productive efficiency and can give a business a competitive advantage - lead to lower prices and higher profits

  as long as the LRAC is declining, then internal economies of scale are being exploited by a business
• diseconomies of scale

  the disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise

  the firms experiences decreasing returns to scale where output increases by a small percentage than inputs
• constant returns to scale

  where firms increase inputs and receive an increase in output by the same percentage
• minimum efficient scale

  minimum level of output needed for a business to fully exploit economies of scale

  the point where the LRAC curve first levels off and when constant returns to scale is first met
• minimum efficient scale

  A) minimum efficient scale

  B) diseconomies

  C) economies

  D) constant returns to scale

  
• types of internal economies of scale

  • technical
  • managerial
  • financial
  • marketing
  • network
• types of internal economies of scale - technical


  cost savings the firm makes as it grows larger due to the increasing use of large scale mechanical processes and machinery

  large companies can afford to invest in specialist capital machinery

  container principle - doubling height, width and tanker more than proportionally increases cubic capacity
• types of internal economies of scale - managerial


  employing specialised staff to increase efficiency, better management and increase investment in human resources

  use of specialist equipment can improve communication, increase productivity and decrease unit costs
• types of internal economies of scale - financial


  markets usually rate larger, more established firms to be more credit-worthy and have more access to loans at more favourable rates of borrowing, may borrow more than a small firm at a lower rate of interest
• types of internal economies of scale - network


  marginal cost of adding one more user to the network is close to zero but resulting financial benefits may be huge as each new member can interact with other members, also risk bearing economies often derived by large firms who can beat business risks more effectively than smaller firms
• types of internal economies of scale - marketing


  large firms can buy factor inputs in bulk at lower prices if it has monopsony power (they are they only buyer) - these are purchasing economies
• long run average cost curve (LRAC)

  known as the 'envelope curve

  points of tangency between the LRAC and SRAC curves do not occur at the minimum points of the SRAC curves except at the point where minimum efficient scale (MES) is achieved

  if LRAS is falling when output is increasing then the firm is experiencing economies of scale

  when LRAC eventually starts to rise then the firm experiences diseconomies of scale, and if LRAC is constant then the firm is experiencing constant returns to scale

  working assumption that a business will choose the least-cost method of production in the LR
• internal economies of scale

  economies of scale arise from increasing returns to scale in the long run

  
• external economies of scale

  occur outside a firm but within an industry - arise from the growth of an industry

  
• external economies of scale involve changes outside of the business i.e. they result from the expansion of the entire industry of which the business is a member

  they lower unit costs for many/all firms inside the market
• examples of external economies of scale

  transport networks lowering logistics costs

  relocation of suppliers to the centre of production

  influx of human capital - highly skilled workers

  University Research Departments helping to fund research
• agglomeration economies are important

  businesses in similar industries tend to cluster together and attract an influence of skilled talent which then provides human capital to expanding businesses
• evaluating economies of scale

  all businesses can exploit some internal economies of scale

  the nature of production/technology requirements will influence the size of MES relative to market demand

  economies of scale may run out at a certain point but constant returns to scale means that unit costs will be stable

  many economies depend on businesses achieving a high rate of capacity utilisation - lower fixed cost per unit
• internal economies of scale

  expansion of the firm itself

  lowers LRAC as increasing output

  increasing returns from large scale production

  range of economies e.g. technical and financial
• external economies of scale

  expansion of the industry of which the firm is a member

  benefits most/all firms

  agglomeration economies are impartant

  helps explain the rapid growth of many cities
• economies of scope

  happen when it is cheaper to produce a range of products rather than specialise in a limited number
• diseconomies of scale

  lead to a rise in a firm's long run average cost of production

  result from a business expanding beyond an optimum size and losing productive efficiency
• diseconomies of scale - 4C's

  control

  communication

  co-operation

  culture
• diseconomies of scale - 4C's - control

  i.e. problems in monitoring productivity and work quality, risking increase wastage of resources which adds to cost but not to total output
• diseconomies of scale - 4C's - communication

  more workers, stores, factories etc lead to greater costs in terms of communicating
• diseconomies of scale - 4C's - co-operation

  workers in large firms may develop a sense of alienation and loss of moral, harder for firms to get everyone working towards the same goal
• diseconomies of scale - 4C's - culture

  negative effects of internal politics, information overload, unrealistic expectations among managers and cultural clashes between senior people with inflated egos
• causes of diseconomies of scale

  increased regulatory costs for bigger businesses

  office politics/industrial relations

  risk aversion among salaried staff

  waste/inefficiency in large organisations
• effects of diseconomies of scale

  a business has moved beyond their optimum size

  suffering from productive inefficiency

  higher unit costs will reduce total profits

  business may then have to charge higher prices to cover increased costs

  lost competitiveness lead to declining market share and fall in share price

  firm may become 'too large' to respond effectively to changes in consumer taste