Horizontal Boundaries of the Firm

Question 1

Define Economies of Scale

Answer 1

Bigger is better

the production process for a specific good or service exhibits EoS over a range of output when average cost[AC] declines over that range

e. g. AC declines as output increases, then Marginal Cost (MC) must be less than AC
e. g. AC increases, MC must exceed AC = diseconomies of scale

Question 2

Define Average Cost

Answer 2

cost per unit of output

Question 3

u-shaped AC curve

Answer 3

AC declines initially as FC is spread over additional units of output.
AC eventually rise as production runs up against capacity constraints = capacity constraints kick-in (diseconomies of scale appear)

• usually in Short-run
  as firms trying to expand output run up against capacity constraints

Question 4

L-shaped AC curve

Answer 4

• if U- small and large firms would have higher costs than medium firms = but large firms rarely at cost disadvantage
• AC decreases until MES
• firms operating beyond MES have similar average costs

Long Run

• firms expand by building new facilities
• if new facilities operate efficiently, then l-shaped

Question 5

Define minimum efficient scale (MES)

Answer 5

the lowest point on a cost curve at which a company can produce its product at a competitive price

Question 6

What does economies of scale do?

Answer 6

• Create cost advantages
  
  • Determine market structure and entry
  • Affect the internal organisation of firms
    
    • Determine firms’ horizontal boundaries

Question 7

Standard sources of Economies of Scale and Scope

Answer 7

§ Indivisibilities
□ Certain inputs can’t be scaled down below a minimum
□ Lead to FC and economies of scale and scope

§ Spreading of fixed costs

§ Technology Trade-offs

§ Division of Labour (Specialisation)

Question 8

Define Economies of Scope

Answer 8

• Cheaper for one firm to produce both X and Y, than for two different firms to specialise in X and Y each

§ TC(QX, QY) < TC(QX, 0) + TC(0, QY)
§ TC(QX, QY) – TC(0,QY) < TC(QX, 0)

Production of Y reduces the incremental cost of producing X

Question 9

Indivisibilities

Answer 9

Input cannot be scaled down below a certain minimum size

FC arise when there are Indivisibilities in production
- scale and scope economies at different levels
Product Level
Plant Level
Multiplant Level

Question 10

Spreading of fixed costs

Answer 10

□ Product-Specific FC (or, sector-specific?)

e. g.
- special equipment;
- R&D;
- Specialised equipment
- specialised knowledge/labour
- training expenses;
- setup costs;
- simple production processes]

Question 11

Technology Trade-offs

Answer 11

look at graphs

Question 12

Division of Labour (Specialisation)

Answer 12

• to become specialists individuals or firms must make substantial investments- but only is demand justifies it i.e. extent of the market
  e. g. doctors - look at graphs

Question 13

Special sources of Scale and Scope:

Answer 13

§ Economies of Density

§ Purchasing

§ R&D

§ Advertising/Marketing/Brand Management e.g. umbrella branding

§ Production and Cube-Square Rule
Inventories

Question 14

Economies of Density

Answer 14

cost savings that arise within the transportation network due to greater geographic density of customers

Result from:

• increasing the no. of customers using a given network
• reducing the size of the area = reduce cost of network & maintain no. of customers

Question 15

Purchasing

Answer 15

• bulk buying leads to discounts

Why suppliers care:

• less costly to sell to single buyer
• bulk purchaser has more to gain from best price hence is more price sensitive
• supplier may fear costly disruption to operations

Question 16

Advertising

Answer 16

(Cost of sending a message/ Number of potential consumers receiving the message)

Advertising cost per consumer:

(Number of actual consumers as a result of message/ Number of potential consumers receiving the message)

Larger firms enjoy lower advertising costs per consumer

• lower costs per message per potential customer
• higher advertising reach

Question 17

Advertising Reach and umbrella Branding

Answer 17

• effectiveness of a firm’s ad may be higher if that firm offers a broad product line under a single brand name
  e. g. Samsung mobile may encourage purchase of TV

Question 18

R&D

Answer 18

All firms can lower average costs by amortizing R&D expenses over large sales volumes
- does not imply larger firms are more innovative than smaller firms

Question 19

Physical Properties of Production

Answer 19

Economies of scale may arise

Cube-Square Rule
production capacity is proportional to the volume of the production vessel

As capacity increases, AC of producing at capacity decreases, as ratio of Surface Area: Volume decreases
- physical properties of production often allow firms to expand capacity without comparable increases in costs

Question 20

Inventories

Answer 20

firms carry inventory to minimize the chances of running out of stock
Inventory costs drive up AC of good that are actually sold

Inventory costs are proportional to the ratio of inventory holdings : sales

Question 21

Limitations of Economies of Scale and Scope

Answer 21

Diseconomies of Scale: 
• Labour Costs (Wages) and Firm Size
• Spread too thin 
• Bureaucracy:
• Incentives and co-ordination
• Impact upon intrapreneurship and innovation?

Diseconomies of Scope
• Umbrella branding?
• ‘Conflicting out’?
• Strategic fit?

Question 22

What are Complementaries

Answer 22

Synergies among organizational practices

• the benefits of introducing one practice are enhanced by the presence of others
  e. g. fast turn around of flights and not catering

Concept of complementaries known as strategic fit

Question 23

What is Strategic Fit

Answer 23

• Complementarity that yields economies of scope
• Means that (simple/piecemeal) copying of corporate strategy by rivals unproductive
• Porter: Strategic fit is essential for long term competitive advantage