Chapter 11: Firm Behaviour - Economies and Diseconomies of Scale

Question 1

What are the three scales for long run production and costs? (3)

Answer 1

• increasing returns to scale
• constant returns to scale
• Decreasing returns to scale

Question 2

what is increasing returns to scale?

Answer 2

• when all inputs are increased by a given proportion, output increases more than proportionately
  same as economies to scale

Question 3

What is constant returns to scale?

Answer 3

• output increases in direct proportion to an equal proportionate increase in all inputs

Question 4

What is decreasing returns to scale?

Answer 4

• an equal proportionate increase in all inputs leads to a less than proportionate increase in output
  aka diseconomies to scale

Question 5

When does a firm enjoy economies to scale (IRTS)? (3)

Answer 5

• when LRATC is decreasing
• the more output produced, the lower the cost per unit
• so if we double the cost of production (doubles the input) we more than double output

Question 6

What reasons outline benefits to economies to scale? (3)

Answer 6

1. Gains from specialization
2. Effective use of capital (ie. production lines)
3. Indivisible factors of production (or lumpy inputs)
   - ie. annual licenses, advertising costs, other start-up costs. THIS IS KEY

Question 7

When does a firm hit diseconomies to scale? (3)

Answer 7

• when LRATC is increasing
• the more output produced, the higher the cost per unit
• if we double the cost of production (double inputs), the increase in output is less than doable
• ex getting too big bc firm is too big to manage

Question 8

What 2 reasons cause DRTS?

Answer 8

1. more management - communication and decision making problems
2. Shirking (difficulty in monitoring employees)

Question 9

Why does a firm have constant returns to scale?

Answer 9

• there may be a large amount of quantity for which the firm has this
• if the firm increases its output over a portion of the LRATC curve, cost per unit stays the same

Question 10

What is the minimum efficient scale?

Answer 10

• a threshold size (operating level) such that no further economies of scale can be realized

Question 11

What are 4 long term factors affecting production and costs?

Answer 11

1. technological change and globalization
2. Clusters and externalities
3. Learning by doing
4. economics of scope

Question 12

Why does technological change and globalization affect production and costs? (2)

Answer 12

• reduce costs and increases the point of minimum efficient scale
• graphically this shifts the minimum of the LRAC rightwards and downwards

Question 13

Why do clusters and externalities affect production and costs?

Answer 13

• groups of like firms or works exchanging information and ideas
  ie. silicone valley

Question 14

Why does learning by doing affect production and costs?

Answer 14

• costs decline over time due to learning
• incumbents have a cost advantage

Question 15

Why does economics of scope affect production and costs?

Answer 15

• multi-product supply may be less costly than single product supply

Question 15

Why does economics of scope affect production and costs?

Answer 15

• multi-product supply may be less costly than single product supply