Economies of scale

• Economies of Scale


  A proportionate savings in costs gained by an increased level of production by having lower average costs
• Internal economies of scale

  Economies of scale that arise from the expansion of a firm leading to lower average costs
• Economies of scale are the savings that a firm gains from large scale production that results in lower average cost of production
• Internal economies


  • Advantages/savings that a firm gains from within the firm
  • External economies: advantages gained from outside the firm
• Types of internal economies

  • Technical economies
  • Financial economies
  • Managerial economies
  • Purchasing economies
  • Risk bearing advantages
  • Marketing economies
  • Technological economies
• Technical economies


  Gained from better methods of production
• Automated processes reduce cost of production in the long run
• Internet selling and video conferencing are examples of technical economies
• Financial economies


  Larger firms obtain cheaper interest rates and find it easier to borrow
• Managerial economies


  Larger firms can attract more skilled managers and hire specialists
• Cost savings will result if specialist managers are employed
• Purchasing economies


  Buying in bulk leads to cheaper average costs and discounts
• Risk bearing advantages


  Larger firms can spread risks through product, market, and supplier diversification
• Marketing economies


  Large scale firms can promote products at lower rates
• Technological economies


  By buying new and better technology, firms can increase sales volume and reduce costs
• External economies of scale

  Arise from the growth of the industry rather than from the firm itself
• Examples of external economies

  • Improved transport and communication links
  • Improved educational facilities
  • New suppliers emerge
  • Improved housing and social facilities
  • Establishment of new bank branches
• Internal diseconomies


  Factors that lead to increased average costs within a firm
• Examples of internal diseconomies

  • Poor communication
  • Lack of commitment from workers
  • Weak co-ordination
• External diseconomies


  Factors that lead to increased average costs outside a firm
• Examples of external diseconomies

  • Rising labour costs
  • Congestion and pollution
  • Rising wage costs
  • Land shortages
  • Rising fixed costs
• Minimum efficient scale


  Lowest level of output at which costs are minimized
• The point at which long-run average costs stop falling is known as the minimum efficient scale
• Total revenue (TR)


  The sales of a firm obtained by multiplying the price of a good by the number of units sold
• TR = P x Q
• Average revenue (AR)


  The revenue per unit of output sold
• AR = TR / Q
• Marginal revenue (MR)


  The additional revenue arising from the sale of an additional unit of output
• In the short run, a firm making losses could stay in business if it can cover AVC
• Normal profit


  A minimum level of profit that reflects what could have been earned elsewhere with the resources available
• Supernormal profit


  Any profit over and above normal profit
• Supernormal profit = total profit - normal profit
• Subnormal profit


  When the profit earned by the firm is less than normal profit
• In a fully competitive market, the firm has no control over the price of its goods
• The firm is a price taker in a fully competitive market
• The firm’s demand curve will be horizontal and its revenue will depend entirely on the amount of goods sold
• In any other type of market, the firm will face a downward sloping demand curve
• The firm is a price maker in any other type of market
• If the firm chooses to increase output

  Price will fall
• If the firm decides to reduce output

  Price is expected to increase