Date post: | 28-Dec-2015 |
Category: |
Documents |
Upload: | lisa-griffin |
View: | 218 times |
Download: | 4 times |
Economies and Diseconomies of Scale
Economies and Diseconomies of Scale
Department of Economics and Business DIC
Economies and Diseconomies of Scale
Economics of Large Scale Production
Why are businesses such as Cunard building a new generation of “super-cruisers” capable of carrying over 3,000 passengers?
Why can Tesco Lotus sell food and other products at considerably lower prices than local shops?
Why is the most car factories so large?
Why is Coca Cola able to spend huge sums every year on high profile advertising around the globe?
What are the possible economies of scale available to the main international manufacturers of mobile phones?
Economies and Diseconomies of Scale
Long-run returns to scale
Labour Input Plant 1 Plant 2 Plant 3 Plant 410 4020 16030 24040 275
Capital Input 10 20 30 40
A firm manufacturers casual sports clothing using variable inputs of labour and capital. The total output (shirts per day) that results from changing these inputs is shown in the table.
What is the nature of the returns to scale?
Economies and Diseconomies of Scale
Returns to scale
Increasing returns to scale when the % change in output > % change in inputs E.g. a 30% rise in factor inputs leads to a 50% rise in
output
Decreasing returns to scale when the % change in output < % change in inputs E.g when a 60% rise in factor inputs raises output by only
20%
Constant returns to scale when the % change in output = % change in inputs E.g when a 10% increase in all factor inputs leads to a
10% rise in total output
Economies and Diseconomies of Scale
Scale Economies in the Long Run
Where the expansion of a firm leads to a reduction in long-run average total costs
Occurs when a firm achieves increasing returns to scale
Extent to which economies of scale can be exploited in different industries will vary
Distinction is made between internal and external economies of scale
Some industries can exploit scale economies over a very large range of output
known as Natural Monopolies
Economies and Diseconomies of Scale
Internal Economies of Scale
Technical Economies Law of Increased Dimensions
Cubic law applied – volume increases more than proportionate to surface area
Large-scale indivisible units of capital machinery
Specialisation / Division of Labour within businesses
Financial Economies Bulk purchasing economies Access to cheaper sources of finance
Economies and Diseconomies of Scale
Law of Increased Dimensions
Warehousing/Storage
Transportation
Food Retailing
Super-Cruisers
Hotels
Transatlantic airlines
Motor manufacturing
Oil & Gas distribution
Economies and Diseconomies of Scale
Scale economies continued
Marketing Effective use of advertising / promotion Heavy advertising spending can be spread over huge
volumes of sales – reduces the marketing costs per unit
Risk-Bearing Diversification of products – multi-product firms Diversification of plant locations / retail outlets
By-Products Production of one product generates the supply of
another by-product
Economies and Diseconomies of Scale
Applications of economies of scale
Tesco Lotus in Phuket Marketing economies
Bulk buying products direct from the manufacturerSpreading advertising costs over a very large volume
Technical economiesExploiting the law of increased dimensions with larger storesUse of expensive capital machinery and technology with check-outs and warehouse facilitiesManagerial specialists in the stores
Risk-bearing economiesDiversification of products sold within super-marketsDiversification of outlets in different regions and countries
Economies and Diseconomies of Scale
Motor Car Manufacturers
Financial economies Discounts on buying components Lower interest rates on loans to finance new capital
Technical economies associated with mass production Exploiting economies of linked processes Economies of increased dimensions in massive factory
sizes Exploitation of the principle of division of labour
Marketing economies (as with previous examples)
Risk-bearing economies - wider product range
Economies and Diseconomies of Scale
A Decreasing Cost Industry
Output (Q)
Costs
Long Run Average Cost
Long run average cost falls as output increases – scale economies are exploited across a large range
of output
Min AC
AC2
AC1
Economies and Diseconomies of Scale
The Minimum Efficient Scale
Output (Q)
Costs LRAC
Min AC
MES
Diseconomies of Scale
Economies and Diseconomies of Scale
Explaining the Minimum Efficient Scale
MES is the scale of production at which further increases in scale would not lead to lower unit costs (see average costs)
MES is the point on LRAC curve where it flattens out
Where the MES is large and requires large capital expenditure it may act as a barrier to entry, especially where the MES is large in relation to total market size
With a natural monopoly there is room for only one business in the market to reach the MES given the total size of the market
Often a number of firms may operate profitably below MES because the cost disadvantage of doing so is small, or because of product differentiation
Economies and Diseconomies of Scale
Diseconomies of Scale
Diseconomies of scale leads to rising long-run average costs
LRAC rises due to decreasing returns to scale I.e. firms expanding beyond their optimum scale
Diseconomies are difficult to identify precisely
Often caused by the complexities of managing large-scale corporations Problems (and costs) of administration and coordination Growth of bureaucracy Risk of increasing worker alienation/shirking Increasing transportation costs to distant markets (arising
from geographical location of major plants)
Economies and Diseconomies of Scale
Diseconomies of Scale – LRAC
Output (Q)
Costs
LRAC
MES
From here diseconomies result in average costs increasing
Economies and Diseconomies of Scale
External Economies of Scale
External economies arise because the development / expansion of an industry can lead to the benefit to all firms in the industry A labour force skilled in the crafts of the industry Components suppliers equipped to supply the right parts Trade magazines in which all firms can advertise cheaply
External economies partially explain the tendency for firms to cluster geographically
External Diseconomies of Scale These occur when too many firms have located in one area Local labour becomes scarce and firms now have to bid wages
higher to attract and retain new workers Land and factories become scarce and rents begin to rise The local traffic infrastructure become congested and so
transport costs begin to rise
Economies and Diseconomies of Scale
External Economies and Diseconomies of Scale
Output (Q)
Costs
LRAC1
LRAC2
LRAC2
Economies and Diseconomies of Scale
Economies of Scale and Economic Efficiency
Exploitation of internal economies of scale is a move towards productive efficiency in the long run
Lower unit costs lead to higher output and lower prices
PO 2003
Now copy this file to your user area so you can modify it as you so wish. If you have any questions please see P.O. for extra help