Economies and diseconomies of scale Flashcards
What is the long run
Period of time where all factors of production are variable so firms can now increase any of the factors of production
What are long run costs based on
- Since there is no law of diminishing returns, long run costs is based on how much output is rising compared to the increase in inputs of variable factors of production
What is increasing returns to scale
- When % increase in outputs is more than the % increase in inputs so there is more efficiency, causing LRAC to decrease
- This is caused by economies of scale
What is decreasing returns to scale
- When % increase in outputs is less than the % increase in inputs, so less efficiency causing the LRAC to increase
- This is caused by diseconomies of scale
What is constant returns to scale
- When % increase in outputs is the same as % increase in inputs
What does the LRAC curve look like
- Decreases at first due to increasing returns to scale
- Then stays constant due to constant returns to scale
- Then increases due to decreasing returns to scale
What is the minimum efficient scale
- Lowest point on the LRAC curve so earliest point where constant returns to scale occurs
Explain the 2 types of economies of scale
- Internal where costs are rising but less than the increase in output
- External where costs are falling as large size causes external benefits without the firm having to do anything
- Both of these decrease AC as AC = TC / Q
What are the types of internal economies of scale
- Risk bearing
- Financial
- Managerial
- Technical
- Marketing
- Purchasing
What are financial economies of scale
Where firms can negotiate lower interest rates as increased size means they are a reputable, profitable firm which are lower risk for banks
(costs are rising as they are paying more interest but output is rising more as they are borrowing more money to spend)
What are managerial economies of scale
Firms are big enough to employ specialist managers who boost productivity and increase output
(costs are increasing as wages increase but boost in output is greater)
What are technical economies of scale
Firm can employ specialist machinery to boost productivity and increase output
(costs are rising as they have to pay for machines but output rising more)
What are marketing economies of scale
Where a firm can bulk buy their advertising
(Costs are rising as they have to buy more adverts but output rising more)
What are purchasing economies of scale
Firms can buy raw materials in bulk
(costs of production rise but output rises more)
What are examples of external economies of scale
- Infrastructure improvements
- Component suppliers move closer
- R&D firms move closer
Explain infrastructure improvements due to external economies of scale
Companies build better infrastructure around your business because it is a hub for the industry, e.g. better transport infrastructure would decrease transport costs
Explain component suppliers move closer due to external economies of scale
Suppliers of the components might move closer to you, as you are their main customer because you are such a big firm. This cuts transport costs
Explain R&D firms move closer due to external economies of scale
R&D firms might move closer and you can use their R&D to improve technology and reduce costs
What are reasons for diseconomies of scale
- More difficult to Control workforce
- Takes too long to Communicate from top of firm to bottom
- Difficult to Coordinate different sections of the business e.g. HR and marketing
- Workers feel insignificant and dispensable so less motivation
These all decrease productivity and increase costs
How do economies and diseconomies of scale link to the shape of the LRAC curve
- If output is already low, increasing size by increasing input of variable factors of production (upscaling) will cause economies of scale so LRAC falls
- If output is already high, upscaling will cause business to get too big causing diseconomies of scale so LRAC will rise
