Long Run Costs & Economies and Diseconomies of Scale

Question 1

What is economies of scale?

Answer 1

falling long run average costs (LRAC) from an increase in output

Question 2

What is internal economies of scale?

Answer 2

Internal economies of scale arise because of the growth in output of the firm itself as it expands its own operations; efficiencies in production are gained reducing LRAC

Question 3

What is external economies of scale?

Answer 3

External economies of scale arise from factors outside the firm because of the growth in the size of the industry or the business environment in which the firm operates, reducing LRAC for individual firms

Question 4

What are types of internal EoS?

Answer 4

Technical EoS = use of specialised equipment, automated manufacturing; law of increased dimensions e.g.containerisation,
Purchasing EoS = lower price per unit from bulk buying, larger firm can use its monopsony power
Managerial EoS = using specialist staff, a form of the division of labour, e.g.specialist production manager
Financial EoS = bigger firms are often less risky and can get bigger loans at lower interest rates than smaller firms
Risk-bearing EoS = larger firms can diversify to spread risk; makes business more resilient to changes in market conditions

Question 5

What are types of external economies of scale?

Answer 5

• Infrastructure: industries cluster geographically to benefit from shared infrastructure, e.g. Media City in Salford; fishing industry in Grimsby
• Knowledge & labour pool: in some regions there may be a strong knowledge sharing environment e.g. City of London, Cambridge Uni & Science Park
• Supplier networks: clusters of related businesses can lead to a strong supplier network e.g.specialised components in automotive industry

Question 6

Explain the LRAC curve and what it looks like

Answer 6

• If LRAC is falling when output is increasing, then the firm is experiencing economies of scale.
• Conversely, when LRAC eventually starts to rise then the firm experiences diseconomies of scale
• If LRAC is constant, the firm is experiencing constant returns to scale

Question 7

What are external EoS on an LRAC curve?

Answer 7

External EoS cause the firm’s LRAC to shift down – lower average costs at every output level.
External diseconomies of scale would shift it up

Question 8

Explain and show the MES.

Answer 8

MES: the lowest output Q1 where the firm is at the lowest point on the LRAC
The business achieves productive efficiency.
If the MES is low relative to total market output, then it is likely there will be a large number of small firms in the industry and vice versa