3.1.7 - Economies and Diseconomies of scale

Question 1

What happens when a firm increases its scale of production?

Answer 1

A firm increases its inputs of all factors of production: more land, more buildings, more machinery, and more workers.

This process involves adjusting all resources used in production.

Question 2

Can a change in the scale of production occur in the short run?

Answer 2

No, because at least one factor of production is fixed in the short run.

Firms can only change their scale of production in the long run when all factors are variable.

Question 3

What are returns to scale?

Answer 3

Returns to scale describe the relationship between changes in scale of production and changes in output.

This concept has significant implications for a firm’s costs.

Question 4

What are increasing returns to scale?

Answer 4

Increasing returns to scale occur when a proportionate increase in all factors of production leads to a more than proportionate increase in output.

This results in a fall in the average cost per unit of output.

Question 5

Provide an example of increasing returns to scale.

Answer 5

If land, labour, and capital are doubled, output increases by more than double.

This leads to economies of scale.

Question 6

What are decreasing returns to scale?

Answer 6

Decreasing returns to scale occur when a proportionate increase in all factors of production leads to a less than proportionate increase in output.

This results in a rise in the average cost per unit of output.

Question 7

Provide an example of decreasing returns to scale.

Answer 7

If all factors of production are doubled, output increases by less than double.

This leads to diseconomies of scale.

Question 8

What are constant returns to scale?

Answer 8

Constant returns to scale occur when a proportionate increase in all factors of production leads to a proportionate increase in output.

The average cost per unit of output remains constant.

Question 9

Fill in the blank: A firm can only change its scale of production in the _______.

Answer 9

long run.

Question 10

True or False: In the long run, all factors of production are fixed.

Answer 10

False.

Question 11

What happens to average cost per unit of output during increasing returns to scale?

Answer 11

It falls.

Question 12

What happens to average cost per unit of output during decreasing returns to scale?

Answer 12

It rises.

Question 13

What is the outcome when constant returns to scale occur?

Answer 13

Output doubles when all factors of production are doubled, and average cost per unit stays constant.

Question 14

What is the Short Run Average Cost (SRAC) curve?

Answer 14

The SRAC curve shows the cost per unit at different levels of output given a particular amount of capital.

Question 15

What happen to the SRAC curve if a different quantity of capital is employed?

Answer 15

A different SRAC curve would apply corresponding to that different quantity of the fixed factor.

Question 16

How many different SRAC curves can exist?

Answer 16

There can be many different SRAC curves, each corresponding to a different scale of production.

Question 17

What is the significance of fixed factors in the short run?

Answer 17

In the short run, at least one factor of production, generally assumed to be capital, is fixed in supply.

Question 18

What does the LRAC curve represent?

Answer 18

The LRAC curve is an ‘envelope’ of all the possible SRAC curves.

Question 19

What does a firm do in the long run regarding capital?

Answer 19

In the long run, capital becomes a variable factor, and the firm can choose which quantity of capital to employ.

Question 20

What will a profit-maximizing firm choose in the long run?

Answer 20

It will choose whichever quantity of capital minimizes its average costs of production given its level of output.

Question 21

What happens to the average cost of production when increasing from SRAC1 to SRAC2?

Answer 21

The average cost of production is lower on SRAC2, hence the firm will choose to increase its scale of production.

Question 22

Fill in the blank: The LRAC curve consists of a series of points on the different _______ which represent the lowest average costs attainable to produce any given output.

Answer 22

short-run average cost curves

Question 23

True or False: In the short run, a firm can vary its input of capital.

Answer 23

False

Question 24

What is the original short-run average cost curve of a firm beginning operations?

Answer 24

SRAC1

Question 25

If a firm wishes to increase output from q1 to q2, what options does it have?

Answer 25

It can either continue producing on SRAC1 or move onto SRAC2.

Question 26

What does the term 'envelope' refer to in the context of LRAC?

Answer 26

It refers to the LRAC being formed by the lowest points of all SRAC curves.

Question 27

Fill in the blank: The firm will always choose the _______ method of production in the long run.

Answer 27

least-cost

Question 28

What is the relationship between output levels and SRAC curves?

Answer 28

Different levels of output correspond to different SRAC curves based on the quantity of capital employed.

Question 29

What causes the LRAC curve to be U-shaped?

Answer 29

Internal economies and diseconomies of scale

Question 30

What happens to average costs as a firm expands its capacity initially?

Answer 30

Average costs fall due to economies of scale

Question 31

What is the optimum size of the firm on the LRAC curve?

Answer 31

Output Q* on SRAC3

Question 32

What is achieved at the optimum size of the firm?

Answer 32

Productive efficiency is maximised

Question 33

What occurs if there is a further increase in the scale of production beyond the optimum size?

Answer 33

Falling efficiency and rising average costs

Question 34

What are the reasons for the U-shape of SRAC curves?

Answer 34

Increasing and diminishing marginal returns

Question 35

When do increasing and diminishing marginal returns occur?

Answer 35

In the short run when there is a fixed factor of production

Question 36

What does MES stand for?

Answer 36

Minimum Efficient Scale of production

Question 37

What is the definition of Minimum Efficient Scale of production (MES)?

Answer 37

The lowest level of output at which costs per unit are minimised

Question 38

What does it mean for a scale of production to be productively efficient?

Answer 38

It means that costs per unit are minimised

Question 39

How does MES vary between firms?

Answer 39

It varies considerably, explaining the presence of many small firms in some industries and only a few large firms in others

Question 40

Fill in the blank: The MES is the lowest scale of production which is _______.

Answer 40

productively efficient

Question 41

True or False: MES is the same for all firms in an industry.

Answer 41

False

Question 42

What does a high MES mean for a firm and an industry?

Answer 42

A high MES means that the industry is likely to be dominated by a small number of large firms This is because only large firms will be able to attain maximum efficiency and smaller firms will be competed out of the market. Thus, a high MES acts as a considerable barrier to entry - as competition is restricted by the fact that new entrants producing low outputs will not be able to compete with established firms.

Question 43

What does a low MES mean for an industry?

Answer 43

* A low MES means that there are likely to be many firms in the industry, since maximum efficiency can be gained by relatively small firms who will thereofre be able to compete effectively * A low MES means that EoS will not be an important barrier to entry, since new entrants need to produce only a small output to compete on costs with established firms.

Question 44

Fill in the blank: A high MES typically indicates that an industry is ____________, whereas an industry with a low MES is typically ___________.

Answer 44

Uncontestable, Contestable