4.5 Economies And Diseconomies Of Scale Flashcards
What are economies of scale?
As output increases long-run average cost falls
(Falling costs of production as firm gets bigger)
What is diseconomies of scale?
As output increases long-run average cost rises
(Rising costs of production as firm gets bigger)
What is the curve of economies of scale look like?(ouput x axis cost y axis) LRAC
Downward shifting to the riggt
What does the curve of diseconomies of scale look like? (ouput x axis cost y axis) LRAC
Rising to the right
What is the u shape in the short run ATC explained by?
-labour becomes more productive as it is added to fixed capital before becoming less productive because of the law of diminishing returns
What is the u shaped in the Long run average total costs explained by?
-economies of scale
-diseconomies of scale
They don’t occur in the short run
Explain the LRAC SRATC graph
There are a number of SRATC curves lying along the LRAC curve. Each of the SRATC curves demonstrates a different firm size. Firms can move from SRATC1 to SRATC2 in the long run. The LRAC curve forms a tangent with all of the SRATC curves.
Where do all firms aspire to be on the LRAC graph
The turning point between the economies of scale and diseconomies of scale
What are internal economies and diseconomies of scale?
Changes in long-run average cost of production resulting in chafes in the size or scale of a firm or plant
What is an external economies of scale?
Average long-run costs of production fall because for the growth of industry that the firm is a part of
What are external diseconomies of scale?
Average long-run costs of production increase because of the growth of the whole industry or market
What are the types of internal economies of scale?
-technical
-managerial
-marketing
-financial or capital-raising
-risk-bearing
-economies of scope
What are technical economies of scale?
Changes to productive process as the scale of production and level of output increases
What is the productive process?
Method of employing each factors of Production to provide goods and services to consumers
What can technical economies or scale be cussed by?(5 aspects)
-invisibilities
-spreading of research and development costs
-volume economies
-economies of massed resources
-economies of vertically linked processes
What are invisibilities?(sub)
Types of plants or machinery that are invisible in the sense that there is a certain minimum size below which they cannot efficiency operate
What are the spreading of research and development costs?(sub)
-with large plants research and development costs can be spread over a longer production run(reducing unit costs in the long run)
What are economies of massed resource?(sub)
Operation of a number of identical machines in a large plant means proportionately fewer spare parts kept than when fewer machines are involved
Economies of vertically linked progress?(sub)
Manufacturing involves a large number of vertically related tasks and processes
-initial purchase of raw materials
-component and energy
-sale of finished product
-linking of these processes can lead to savings in time, transports costs and energy
What is a volume economy?(sub)
With types of capital equipment, costs increase less rapidly than capacity (when a storage tank is doubled it increases capacity)
What are economies or scope
Factors that make it cheaper to produce a range of products together rather than each one on its own
(E.g businesses sharing centralised functions such as marketing or finance)
What are marketing economies of scale?
Two types:
Bulk-buying
Bulk-marketing economies
-large firms can use their market power to buy supplies at lower prices and negotiate better terms with retailers
Managerial economies or scale?
The large the firm the greater it’s ability to benefit from specialisation and the division of labour(with ordinary work force and management)
-firm can benefit from Devision of labour mainly by the employment of specialist managers
Financial or capital-raising economies or scale?
Relate to ‘bulk-borrowing’ required to finance an expansion in the firm
-large firms can borrow from banks with a lower rate of interest than small firms
Risk-bearing economies of scale?
Usually less exposed to risk than small firms
-risks can be spread by diversifying output, their markets and sources of supply
-makes the firm less vulnerable to changes in conditions of supply and demand that would otherwise harm them
What internal diseconomies of scale can firms suffer from?
-managerial
-communication failure
-motivational
What is managerial diseconomies of scale?
As firm grows, administration becomes harder. Delegation of some of the firms managerial functions to those lower In the organisation may mean people who lack appropriate experience make poor decisions (increases average costs of production)
What is communication failure?
(Contributed to managerial diseconomies of scale)
-in a firm there can be too many layers of management between top management and production workers so staff can feel remote and unappreciated. When labour productivity begins to fall production costs rise
Motivational diseconomies of scale?
With large firms it can be hard to satisfy workers-over-specialisation may lead to de-skulking where workers perform basic boring tasks and have little personal incentive to help the employer
Why is it important to distinguish between economies of scale at a single plant and those across the whole firm?
Firms can grow larger without the plants they own and operate growing significantly in size
What is the link between economies and diseconomies of scale and returns to scale?
Increasing returns scale led to falling long-run average costs or economies of scale
Decreasing returns scale lead to increase long-run average costs or diseconomies of scale
Explain the effects of increasing return to scale on long run average costs?
-output increases faster than inputs so if wage rates and other factors are the same at all levels of outputs, the Money costs for producing a unit of output must fall
-with decreasing returns to scale outputs increases at a slower rate than inputs and the monetary cost of producing an output rises
What are external economies of scale often produced by?
Cluster effects
What is the cluster effect?
When a clot of firms in the same industry are are located near each other
-providing for each other
-markets
-sources of supply
-pool of trained labour
What can diseconomies of scale be caused by?
The cluster effect again(ikr)
-a larger number of firms next to each other may get in each other’s way and competition for labour may increases wages
(Also increases in local traffic congestion slows down everything)
Why are economies of scale not as important as they used to be in car manufacturing?
-market fragmentation, leads to lower production runs and new ways of assembling finished cars such as outsourcing more and more f the car to outside suppliers
What is fragmentation?
organization of production into different stages, which are divided among different suppliers often are located in different countries.
Does the LRATC graph always have to be a symmetrical u shape and why?
No because it can have a horizontal where the exhaustion of benefits to the economies of scale does not immediately lead to the start of the diseconomies of scale
What does a LRATC line that is completely horizontal illustrate?
Depicts a market or industry in which firms neither benefit from economies of scale not suffer from the diseconomies of scale
(Consistent long run average costs)
Describe the SRATC on the LRATC
U shaped SRATC are situated on the big LRATC everywhere along its length
Eg. SRATC1-SRATC-11 on one LRATC
What markets are the services provided small scale of production?
Common industries of supplying services such as hairdressers and personal trainers
In these personal training and hairdressing services what happens to diseconomies of scale?(small-scale production)
It sets in fairly early
What does a diseconomies of scale lead to on the graph
-U shaped LRATC is ‘skewed to the left’
For large scale production what happens to the LRAC graph?
‘Skewed to the right’, takes time for diseconomies of scale to set in
What factor contributes to markets containing the size of a firm?
“Contracting out” the provision services previously provided in house by workers and managers employed from the firms to ‘outside suppliers’ of the sale service
What do outside suppliers range from?
-small independent firms(such as a sandwich shop) to large-scale specialist firms providing many services
What does long run marginal costs show?
The additional cost incurred if a firm increases output when all the factors of production are variable
Diagram for economies of scale
Describe this diagram?
-number of short run average total costs (SRATC) curves lying on the LRAC curve
-each SRATC represents a firms size and in the long run firm can move from one SRATC to another
-each SRATC curve is associated with a difference scale of capacity that is fixed in the short run
What forms of diseconomies of scale can firms suffer from?
-managerial diseconomies of scale
-communication failure
-motivational diseconomies of scale
What are the reasons for falling long-run average costs (3)
-increasing returns to scale
-effect of bulk buying
-reducing cost of raw materials and components
When does the LRAC curve rise?
When long-run marginal costs rise above long-run average costs(economies of scale)
When does the LRAC fall?
When the long-run marginal costs fall below the long-run average costs(diseconomies of scale)
What is the mathematical relationship of LRMC and LRAC the same as?
Relationship of SRMC and SRATC
What does the L-shaped LRAC curve result from?
The assumption there are substantial economies of scale which give way to the flattering out of the LRAC curve not diseconomies of scale
(Evidence of this in manufacturing industries with large scale production)
What important concept in production and cost does this diagram represent?
Minimum efficiency scale
What is the minimum efficiency scale?
The lowest output at which the LRAC has been reduced to the minimum level that can be achieved (means firms has fully benefited from economies of scale)
All the firms to the left of SRATC are …
Below the minimum efficiency scale
At what point would there be no further reductions in LRPC for any firms?
At the point Q1
What is MES
the lowest point on a cost curve of the economies of scales
