Economies and diseconomies of scale

Question 1

define internal economies of scale

Answer 1

when long run average cost falls, as a firm expand

Question 2

why do internal economies of scale only apply to the long run average costs?

Answer 2

it’s onlyin the long run when firms can expand enough to take advantage of economies of scale.

Question 3

state the 6 types of internal economies of scale

Answer 3

(Richard’s Mum Flies Past The Moon)
- Purchasing economies
- Technical economies
- Managerial economies
- Marketing economies
- Financial economies
- Risk-breaking economies

Question 4

internal economies of scale: define purchasing economies

Answer 4

when firms expand to make bigger purchases, they can negotiate lower prices/reduce LRAC

Question 5

internal economies of scale: how do larger firms benefit from purchasing economies compared to smaller firms and state why

Answer 5

• small firms = will be more expensive to buy factors of production/ raw materials
• larger firms = will be cheaper to buy factors of production/ raw materials
  why?
  Because larger firms are able to negotiate lower prices/ bulk buy. Suppliers need big orders to stay a float and so firms may demand discount for orders (assuming they will make profit) and suppliers will have no choice but to accept - otherwise they may risk loosing a big order

Question 6

internal economies of scale: within purchasing economies how does bulk buying help firms

Answer 6

Bulk buying reduces a firms cost
- More bulk buying mean firms are able to negotiate lower prices
- As firms expand they can bulk buy in bigger volumes, reducing LRAC

Question 7

internal economies of scale: define Technical economies

Answer 7

when big firms invest in specialist capital, increasing a firms productivity and decreasing their LRAC

Question 8

internal economies of scale: how do large firms vs small firms benefit from technical economies of scale

Answer 8

• Big firms can afford and justify spending on specialist capital because they are producing enough output to profit on their investment
• But for small firms producing only are goods, investing in specialist equipment would be bad as they will never sell enough units to cover the cost of investing (too costly).

Question 9

internal economies of scale: what has to take place for technical economies of scale of occur

Answer 9

firms need to scale up and expand = they can exploit technical economies of scale

Question 10

internal economies of scale: define managerial economies of scale

Answer 10

specialist staff/ machinery, each of which are skilled and efficient in their field increases productivity - LRAC will decrease

Question 11

internal economies of scale: how do large firms vs small firms benefit from managerial economies of scale

Answer 11

• Small firms cannot afford specialist staff as it is too expensive = produce only afew units
• Larger firms can exploit managerial economies of scale - can afford

Question 12

internal economies of scale: define marketing economies of scale

Answer 12

when big firms spread their marketing costs across many units = This decreases their LRAC

Question 13

internal economies of scale: how do large firms vs small firms benefit from marketing economies of scale

Answer 13

• a large firm can use marketing economies spread their marketing cost over multiple units they sell to reduce LRAC
• A small company would go bankrupt trying these marketing strategies

Question 14

internal economies of scale: define financial economies of scale and state what would happen to the interest rate when high

Answer 14

when bigger firms are less risky and so can secure cheaper loans, reducing their LRAC
- The higher the risk, the higher the interest rate would be for a bank to lend

Question 15

internal economies of scale: how do large firms vs small firms benefit from financial economies of scale

Answer 15

• bigger firms = banks are willing to lend at lower interest rates, because the high sales/ large profits = the business was deemed as less risky = banks are able to offer lower interest rates
• small firms who are out staring out = much riskier

Question 16

internal economies of scale: define risk bearing economies of scale

Answer 16

Diversifying into new ventures and producing more

Question 17

internal economies of scale: why is risk bearing economies good

Answer 17

when one venture goes bankrupt, your costs will be minimised as you would have other ventures = wouldn’t not be a big impact

Question 18

internal economies of scale: how do large firms vs small firms benefit from risk bearing economies of scale

Answer 18

• Bigger firms can exploit risk bearing economies of scale using their profits to diversify into new areas = reduces cost of failure in one sector
• Smaller firms do not have enough profit to diversify, so the cost of failure is high

Question 19

define internal diseconomies of scale

Answer 19

when an increase in output increases LRAC

Question 20

when can internal diseconomies of scale occur

Answer 20

when a firm expands too much

Question 21

state the three main reasons for internal diseconomies of scale

Answer 21

• Alienation
• Bureaucracy
• Communication

Question 22

internal diseconomies of scale: define alienation

Answer 22

when workers are working in a way where by they are separated from their coworkers

Question 23

internal diseconomies of scale: state how alienate causes internal diseconomies of scale

Answer 23

decreases motivation. As motivation falls productivity falls, and long run average costs rise

Question 24

internal diseconomies of scale: define Bureaucracy

Answer 24

all the paperwork mangers, filing and securities that a firm has to pay for when it gets really big

Question 24

internal diseconomies of scale: state how Bureaucracy causes internal diseconomies of scale

Answer 24

as firms expamd, they will have to hire more managers to supervise staff, fill out more forms to keep track of people’s work and then employ secretaries to help with all the filing
- Spending on bureaucracy is expensive and increases LRAC

Question 25

internal diseconomies of scale: state how Communication causes internal diseconomies of scale

Answer 25

• when firms get larger, communication can slow down
• Slow communication decreases productivity and increases LRAC

Question 25

define the minimum efficient scale

Answer 25

the quantity where a firm first reaches their lowest average cost

Question 26

define External economies of scale

Answer 26

when a firm’s long run average costs fall, as industryoutput increases.

Question 26

what happens to the LRAC curve when there are external economies of scale an why

Answer 26

LRAC decreases because for whatever quantity you produce, external economies of scale will always reduce LRAC (will make it cheaper to produce at all quantities)

Question 26

state the difference between internal and external economies of scale

Answer 26

• internal economies = firms own output gets bigger
  vs
• external economies = an entire industry gets bigger/ expands

Question 27

What does a firms L- shaped LRAC curve means

Answer 27

Firms are not experiencing LRAC is not increasing = not experiencing decreasing return to scale and diseconomies

Question 28

Why does the L- shaped LRAC curve happen

Answer 28

Because the business is being handled well = cutting out diseconomies (ABC)