Economies of Scale

Question 1

Fixed costs

Answer 1

Costs incurred by a firm that do no vary with the level of output

Question 2

Variable costs

Answer 2

Costs that vary with the level of output

Question 3

Total costs (TC)

Answer 3

The sum of all costs that are incurred in producing a given level of output

Question 4

Average Total Costs (ATC)

Answer 4

Total cost divided by the quantity produced often called average cost (AC), also called unit cost

Question 5

Average fixed costs (AFC)

Answer 5

Fixed cost divided by the quantity produced

Question 6

How do you calculate Average Variable Cost (AVC)?

Answer 6

Variable cost divided by the quantity produced

Question 7

Marginal cost (MC)

Answer 7

The cost of producing an additional unit of output

Question 8

Examples of Fixed costs

Answer 8

• Rent

- Salaries

Question 9

Examples of Variable Costs

Answer 9

• Wages
• Commission
• Raw materials

Question 10

Why must the the MC curve cross the AC curve at the lowest point on the AC curve?

Answer 10

• When MC is below AC curve, the cost of one more is bringing the AC down
• When MC is above the AC curve, the cost of one more is bringing the AC up
• When MC is equal to the AC, the MC is not changing the AC, must be equal

Question 11

Short run

Answer 11

Time which a firm is free to vary its input of one factor of production (labour), faces fixed inputs of the other FofP

Question 12

Long run

Answer 12

The period over which the firm is able to vary the inputs of all its FofP

Question 13

Law of Diminishing returns

Answer 13

If a firm increases its inputs of one FofP while holding inputs of other FofP fixed, eventually the firm will get diminishing marginal returns from the variable factor

Question 14

What are Sunk costs?

Answer 14

Costs incurred by a firm that cannot be recovered if the firm ceases trading

Question 15

An example of sunk costs

Answer 15

-Advertising

Question 16

What does the short run AC curve show?

Answer 16

Relationships between the volume of production and costs under the assumption that the quantity of capital and other inputs are fixed - to change the output, the firm has to vary the amount of labour

Question 17

What are economies of scale?

Answer 17

Occur for a firm when an increase in the scale of production leads to production at lower long-run average cost

Question 18

Internal economies of scale

Answer 18

• Economies of scale that arise for the expansion of a firm

- A single business can exploit these as they get larger

Question 19

External economies of scale

Answer 19

Economies of scale that arise from the expansion of the industry in which a firm is operating

Question 20

Technical Efficiency

Answer 20

Attaining the maximum possible output from a given set of inputs

Question 21

What is cost efficiency?

Answer 21

The appropriate combination of inputs of FofP, given the relative prices of those factors

Question 22

Explain the first 1/3 of the Long Run AC

Answer 22

• Increasing returns to scale
• %change output > %change input
• Getting more out, than they are putting in
• Costs (inputs) are rising but output is rising faster AC decreasing

(Economies of scale)

Question 23

Explain the 3/3 of the Long Run AC

Answer 23

• Decreasing returns to scale
• %change output < %change input
• Costs (inputs) are rising and they are getting less in return (output)
• Quantity rising at a slower rate than costs are rising. AC increasing

(Diseconomies of scale)

Question 24

Explain the 2/3 of the Long Run AC

Answer 24

Constant returns to scale
%change output = %change input
AC flat and constant

Question 25

Where would a business want to fully exploit economies of scale on the LRAC

Answer 25

Where AC stops decreasing, lowest level of output required to fully exploit all economies of scale

Question 26

List a few internal economies of scale?

Answer 26

• Technical EofS
• Purchasing EofS
• Managerial EofS
• Financial EofS

Question 27

Some features of Technical EofS?

Answer 27

• Production line methods reduce AC

- Specialised equipment reduces AC

Question 28

Some features of Purchasing EofS?

Answer 28

• Large firms can buy in bulk; this reduces costs because suppliers can produce in large quantities and so reduce their own costs
• Negotiate discounts

Question 29

Some features of Managerial EofS?

Answer 29

-Specialist managers (e.g.finance) gain expertise and experience leading to better decisions

Question 30

List a few external economies of scale?

Answer 30

• More skilled labour

- More regional capital

Question 31

Feature of more skilled labour (External EofS)

Answer 31

-A larger industry has a larger pool of skilled labour (Silicon Valley) so a firm can hire labour more cost effectively

Question 32

Feature of more regional capital (External EofS)

Answer 32

-Larger companies locating in an area may lead to improvements in road networks or local public transport

Question 33

What are Diseconomies of Scale? What can go wrong which can lead to DofS, internal DofS examples?

Answer 33

• An increase in LRAC as output increases

- Control, Communication, Coordination, Motivation

Question 34

Name some external diseconomies of scale examples?

Answer 34

Exhausted local supplies diseconomies - Bulk buying may exhaust nearby, local supplies which leads to increased transport costs of additional supplies bought from further away

Question 35

What may occur if a firm expands across multiple sites in different time zones?

Answer 35

Coordination diseconomies. This is because managers find communicating with their subordinates more complex and time consuming

Question 36

One potential cause for diseconomies of scale?

Answer 36

The greater the proportion of a firm’s costs that are variable costs, the more quickly a firm may hit decreasing returns to scale

Question 37

If the firm benefits from Internal economies of scale, then they are going to be moving down the LRAC curve. Whereas with external economies of scale will look like what on a diagram?

Answer 37

Shift of the LRAC curve downwards. From LRAC1 to LRAC2