Economies of Scale Flashcards
Fixed costs
Costs incurred by a firm that do no vary with the level of output
Variable costs
Costs that vary with the level of output
Total costs (TC)
The sum of all costs that are incurred in producing a given level of output
Average Total Costs (ATC)
Total cost divided by the quantity produced often called average cost (AC), also called unit cost
Average fixed costs (AFC)
Fixed cost divided by the quantity produced
How do you calculate Average Variable Cost (AVC)?
Variable cost divided by the quantity produced
Marginal cost (MC)
The cost of producing an additional unit of output
Examples of Fixed costs
- Rent
- Salaries
Examples of Variable Costs
- Wages
- Commission
- Raw materials
Why must the the MC curve cross the AC curve at the lowest point on the AC curve?
- 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
Short run
Time which a firm is free to vary its input of one factor of production (labour), faces fixed inputs of the other FofP
Long run
The period over which the firm is able to vary the inputs of all its FofP
Law of Diminishing returns
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
What are Sunk costs?
Costs incurred by a firm that cannot be recovered if the firm ceases trading
An example of sunk costs
-Advertising
What does the short run AC curve show?
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
What are economies of scale?
Occur for a firm when an increase in the scale of production leads to production at lower long-run average cost
Internal economies of scale
- Economies of scale that arise for the expansion of a firm
- A single business can exploit these as they get larger
External economies of scale
Economies of scale that arise from the expansion of the industry in which a firm is operating
Technical Efficiency
Attaining the maximum possible output from a given set of inputs
What is cost efficiency?
The appropriate combination of inputs of FofP, given the relative prices of those factors
Explain the first 1/3 of the Long Run AC
- 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)
Explain the 3/3 of the Long Run AC
- 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)
Explain the 2/3 of the Long Run AC
Constant returns to scale
%change output = %change input
AC flat and constant
Where would a business want to fully exploit economies of scale on the LRAC
Where AC stops decreasing, lowest level of output required to fully exploit all economies of scale
List a few internal economies of scale?
- Technical EofS
- Purchasing EofS
- Managerial EofS
- Financial EofS
Some features of Technical EofS?
- Production line methods reduce AC
- Specialised equipment reduces AC
Some features of Purchasing EofS?
- Large firms can buy in bulk; this reduces costs because suppliers can produce in large quantities and so reduce their own costs
- Negotiate discounts
Some features of Managerial EofS?
-Specialist managers (e.g.finance) gain expertise and experience leading to better decisions
List a few external economies of scale?
- More skilled labour
- More regional capital
Feature of more skilled labour (External EofS)
-A larger industry has a larger pool of skilled labour (Silicon Valley) so a firm can hire labour more cost effectively
Feature of more regional capital (External EofS)
-Larger companies locating in an area may lead to improvements in road networks or local public transport
What are Diseconomies of Scale? What can go wrong which can lead to DofS, internal DofS examples?
- An increase in LRAC as output increases
- Control, Communication, Coordination, Motivation
Name some external diseconomies of scale examples?
Exhausted local supplies diseconomies - Bulk buying may exhaust nearby, local supplies which leads to increased transport costs of additional supplies bought from further away
What may occur if a firm expands across multiple sites in different time zones?
Coordination diseconomies. This is because managers find communicating with their subordinates more complex and time consuming
One potential cause for diseconomies of scale?
The greater the proportion of a firm’s costs that are variable costs, the more quickly a firm may hit decreasing returns to scale
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?
Shift of the LRAC curve downwards. From LRAC1 to LRAC2
