3.3.3 Economies and Diseconomies

Question 1

What is long-run production

Answer 1

All factors of production are variable

Question 2

How the output of a business responds to a change in inputs is called

Answer 2

returns to scale

Question 3

Increase returns to scale occur when

Answer 3

The % change in output is bigger than % change in inputs

It impacts on average costs

Its called economies of scale

Question 4

Decreasing return to scale occur when

Answer 4

The % change in output is smaller than the % change in inputs

It is an impact on average cost

Called Diseconomies of scale

Question 5

The nature of the return to scale affect

Answer 5

The shape of a business’s long-run average costs curve

Question 6

How will businesses deal with labour and capital in the long run

Answer 6

For a level of output that combines labour and capital in a way that maximises productivity and reduces unit cost

May involve a process off capital-labour substitution where capital machinery and new technology replaces some of the labour input

Question 7

How would you show a long run average cost curve

Answer 7

• All factors of production are variable and hence scale of production
• Economies of scale exits when long-run average costs fall as output rises
• Lower costs represent an improvement in productive efficiency
• As long as the long run average total cost curve is declining, then international economies of scale are being exploited

Question 8

When the long-run average cost curve starts rising, what is happening?

Answer 8

diseconomies of scale

Question 9

Why would you get confused between short-run average costs curve and long-run average costs curve

Answer 9

Because they are the same shapes

SRAC - explains the law of diminishing returns

LRAC is explained by economies/diseconomies of scale

Question 10

What are the four types of Technical economies of scale

Answer 10

1. Expensive (indivisible) capital inputs
2. Specialisation of the workforce
3. Law of increased dimensions
4. Learn by doing

Question 11

What are the 6 overall types of economies of scale

Answer 11

1. Technical
2. Marketing economies
3. Managerial economies
4. Financial economies
5. Network economies of scale
6. External economies of scale (EEoS)

Question 12

Explain:

Expensive (indivisible) capital inputs

As a type of Technical economies of scale

Answer 12

Large-scale businesses can afford to invest in specialist capital machinery

Which smaller independent stores may not be able to justify this initial cost

Question 13

Explain:

Specialisation of the workforce

As a type of Technical economies of scale

Answer 13

Division of labour - split production process into separate tasks to boots productivity

Question 14

Explain:

Law of increasing dimensions

As a type of Technical economies of scale

Answer 14

Known as the container principle

Explains that in cubic law, doubling the height and width of a tanker or building leads to a more than proportionate increase in cubic capacity

Links to economies of scale in distribution and freight industries

Question 15

Explain:

Learn by doing

As a type of Technical economies of scale

Answer 15

Average costs of production decline in real terms as a result of production experience as businesses cut waste and find the most productive means of producing output on a bigger scale

Question 16

Explain what marketing economies are

Answer 16

In large firms, fixed costs such as advertising campaigns have a small effect on the cost per unit

Large firms can purchase in bulk at a lower price if it has monopsony power - called purchasing economies

Question 17

What are Managerial economies of scale

Answer 17

A type of division of labour where firms employ specialists to supervise production systems

Better management and increased investment of human resources + specialist equipment, can raise productivity and decrease unit costs

Question 18

What are financial economies of scale

Answer 18

Larger firms can be deemed more creditworthy, having access to more favourable rates when borrowing

Small firms on the other hand, often pay high interest rates on overdrafts and loans.

(Businesses quoted on the stock market can normally raise new financial capital more cheaply through sales of equities to the capital market)

Question 19

What are network economies of scale

Answer 19

Some networks and services can benefit hugely from economies of scale, due to the marginal cost of adding one more user to a network is close to zero, but the financial benefit may be huge because each new user to the network can trade with existing members of part of the network#

There are high fixed costs of establishing a network, so the more users the lower the fixed costs per unit are

Question 20

What are external economies of scale

Answer 20

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, shifting the long-run average curve downwards

Question 21

Examples of external economies of scale

Answer 21

• University research departments helping to fund research
• Transport Networks lower logistics costs
• relocation of suppliers to the centre of production
• Influx of human capital - highly skilled workers

Question 22

What are diseconomies of scale

Answer 22

are increases in unit costs (average) cost of supply in the long run due to decreasing returns to scale

Question 23

What do diseconomies of scale mean for a business

Answer 23

• A business has moved beyond their optimum size
• Businesses are suffering from productive inefficiency because of organisational slack
• Breakdown in communication may lead to departure of highly skilled workers from the business
• Worker morale can suffer which reduces productivity and increases unit cost - reduces total profit and business may have to raise prices
• Lostcompeitivness could lead to a declining market share and fall in share price on stock market

Question 24

What can cause diseconomies of scale

Answer 24

• Control + communication problems - struggle to monitor productivity + work quality, risking increasing wastage of resources, adding to total costs
• Co-operation problems - worker may develop a sense of alienation and loss of morale
• Negative effects of internal corporate politics, information overload for employees, unrealistic expectations among managers and cultural clashes between management

Question 25

Consequences of diseconomies of scale

Answer 25

• Diseconomies lead to a rise in a firm’s long run average costs of production
• Losing productive efficiency
• Higher long run average costs will reduce the profitability of a business if its prices remain the same

Question 26

How would you show diseconomies of scale on a graph

Answer 26

The lowest part on the long-run average cost curve (Q1) is where there is the most productive efficiency

Producing beyond that efficient scale leads to lower total profits

Diseconomies of scale cause the unit cost to be higher than at output 1

Question 27

What is the minimum efficient scale

Answer 27

It is the scale of production where all of the internal economies of scale have been fully exploited

MES corresponds to the lowest level of output at which the lowest point on a firm’s long-run average cost curve is reached

Question 28

What is the minimum efficient scale likely to be relative to

Answer 28

The size of the market demand in a very competitive industry

This means there is room for many businesses to compete

Question 29

When is minimum efficient scale likely to be high

Answer 29

in a natural monopoly

which means that the industry will be highly concentrated

Question 30

If the long run average cost remains the same as output increases, then a firm is experiencing what

Answer 30

constant returns to scale

Question 31

How would the minimum efficient scale be shown on a diagram

Answer 31

When there is no increase or decrease in the long-run average cost curve

Question 32

Three causes of a business having a high minimum efficient scale

Answer 32

1. MES will tend to be high when the field costs of setting up production are large, e.g. pharmaceutical company
2. MES will be high when the marginal cost if supplying to extra customers is low relative to the fixed costs, like digital businesses
3. With a natural monopoly, long run average cost may continue to fall across the entire range of output which means the MES is a very high % of total market demand (one firm can exploit economies of scale)

Question 33

Examples of businesses with high Minimum efficiency of scale

Answer 33

Water, gas and electric supply

Underground transport system

Social networks and search engines