Topic 4.5 Economies and Diseconomies Of Scale

Question 1

Economies of Scale

Answer 1

Economies of scale occur when there is a decrease in average total cost as the scale of production increases

Question 2

Internal Economies of Scale

Answer 2

Internal EOS occur when a firm becomes larger and thus the scale of production increases.
Examples of IOES:
1. Risk-bearing#
2. Financial
3. Managerial
4. Technical/Technological
5. Marketing#
6. Purchasing

Question 3

1. Risk Bearing#

Answer 3

IEOS. When a firm becomes larger, it can increase its product range -> spread cost of uncertainty -> if one part fails, they have more parts to fall back on

Question 4

2. Financial

Answer 4

IEOS. Better credit ratings mean the firm can borrow money at lower interest rates -> lower fixed costs -> lower total costs -> lower ac/u

Question 5

3. Managerial

Answer 5

IEOS. Larger firms have division of labour -> workforce is more specialised so more efficient -> lowers ac/u

Question 6

4. Technical/Technilogical

Answer 6

IEOS. Larger firms can afford to invest in newer technology -> lowers ac/u due to ^efficiency

Question 7

5. Marketing#

Answer 7

IEOS. Larger firms can divide their marketing budgets across larger outputs so ac of advertising/unit is smaller

Question 8

6. Purchasing

Answer 8

IEOS. Larger firms can (and have the demand to) bulk-buy - which means each unit will cost cost less for them

Question 9

External Economies of Scale

Answer 9

External EOS due to changes within the industry the firm operates within/other external reasons.
1. Better transport infrastructure
2. More skilled workers within the industry
3. Technological advancements

Question 10

Diseconomies of Scale

Answer 10

These occur when output passes a certain point and average costs start to increase per unit of output produced.
1. Control
2. Coordination
3. Communication

Question 11

1. Control

Answer 11

It becomes harder to monitor/control how productive the workforce is, as the firm becomes larger.

Question 12

2. Coordination

Answer 12

It is complicated and time-consuming to coordinate each worker in a firm - especially when there are 1000s of workers.

Question 13

3. Communication

Answer 13

Workers may start to feel alienated and excluded as the firm grows. This could result in a fall in productivity and average costs/unit fall.

Question 14

Lowest Point on a LRAC curve

Answer 14

The minimum efficient scale of production. This is where the optimum level of output is since costs are lowest, and the economies of scale have been fully utilised.

Question 15

Returns to Scale with EOS and DOS

Answer 15

There is increasing returns to scale with economies of scale.
There is decreasing returns to scale with diseconomies of scale.

Question 16

SRAC = LRAC

Answer 16

The firm operates where it can vary all factor inputs

Question 17

The L-Shaped LRAC Curve

Answer 17

This is a development in cost theory compared to the traditional U-shape curve. It suggests that, to begin with, ac/u decreases quicker as output increases due to EOS.

Even if there are DOS, such as managerial costs, they are offset by the economies of scale gained by technical or production factors. So, the curve levels off, indicating that the ac/u is still falling as output increases, but at a lesser rate.