Costs in the Long-run

Question 1

Long-run

Answer 1

When all factors of productions can be changed and costs are variable in the long run

Question 2

Internal economies of scale

Answer 2

A reduction in the firm’s long run average costs as a result of its level of output increasing

Question 3

Types of economies of scale

Answer 3

1. Purchasing
- they can now buy in bulk and therefore decrease cost per unit
- suppliers dependent on larger firms so more likely to give discounts to ensure loyalty

2. Risk bearing
- they can now afford to diversify their product portfolio
- as demand for one good decreases firms have another good to fall back on and still earn a revenue, don’t have to leave the market

3. Technical
- they can now afford to buy more machinery of higher quality
- become more productively efficient and reduces their long run average costs

4. Financial
- they are now able to get loans for lower interest rates as they will be more trusted by banks and seen as less risky

5. Marketing
- can afford advertising that is better which reduces the cost of advertising
- more spread out over larger amounts of output
- output increases more than the cost of advertising

6. Managerial
- can afford to hire specialised managers which are going to be more efficient so decreased longer on average costs

Question 4

Internal diseconomies of scale

Answer 4

1. Slow decision making
- Now lots of layers of management so decision-making process is longer as it takes more people for the information to go through

2. Worker productivity decreases
- workers feel less appreciated and so less productive
- less time to resolve dispute so our likely to feel unvalued and discontent
- do not have direct relationships with owners which leads to distrust

3. Coordination Problems
- now more teams and more departments for different tasks
- a larger hierarchical structure
- must ensure that one department complete their tasks on time so that the other departments ability to do their task is not hindered

Question 5

Minimum efficient scale

Answer 5

The lowest level of output at which a firm can produce at the lowest possible cost
- output at this level is productively efficient

Question 6

External economies of scale

Answer 6

A reduction in firms long run average costs that result from the growth of an industry
- the firm does not grow but the industry expands

Question 7

Types of external economies of scale

Answer 7

1. Improved infrastructure
- as industry expands it improves geographical mobility so workers more productive which increases output

2. Specialization
- More individuals want to specialize in specific things so firms are able to specialise which allows them to be more efficient and productive in one particular area
- makes less mistakes and so quality increases causing AC to fall

3. Reputation enhancement
- as the industry expands and becomes more well known it acts as free advertisement for firms so increases demand without having to increase costs

4. Skilled labour
- firms can take advantage of skilled workers due to an increasing investment of training for the Industries
- output increases and so average cost decrease as more workers are more productive

5. Ancillary economies
- other firms that are linked to the industry appear around them if they are doing well
- give signals to producers of related firms to move closer and so cheaper for firms to get supplies
- can reduce AC as part of the production process

Question 8

External diseconomies of scale

Answer 8

Increase in firms long run average cost due to a growth of an industry

Question 9

What causes external diseconomies of scale?

Answer 9

• more competition for scarce resources as firms have to pay more to get them
• as an economy expands, skilled labor becomes scarce and the cost of skilled labor increases which means they can demand higher wages which increases longer on average costs

Question 10

Evaluating the significance of economies of scale

Answer 10

1. Nature of the industry
- industries that have really high fixed costs will benefit from economies of scale such as large firms
- depends on how big the firms are in the Industries because for smaller firms there are limits as to how large they can expand

2. PED
- firms with an elastic demand curve do not want to increase output by that much if it means decreasing prices as they can’t maximize profit and revenue
- they instead restrict output to keep prices high
- can only benefit from economies of scale if output is high and prices are low

3. Where production is relative to MES
- if a firm is close to the MES they’re going to be hesitant to increase their output as diseconomies of scales could occur

Question 11

The relationship between average and marginal cost

Answer 11

Before the MES:
- MC < AC so average costs decrease

After the MES:
- MC > AC so average costs increase