Economies of Scale and Market Structure

8/2/2019 Economies of Scale and Market Structure

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Market structure


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Production in the Short Runversus Production in the Long Run

In the short run at least one of the factorsof production remains unchanged (fixed).

In the long run all factors of production

are variable. In a two-input production process, in the

short run, only oneinput is variable.

In a two-input production model, in theshort run, the changes in the output(physical product) are the result of

changes in the variable input.


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Short Run ATC, AVC & SMC CostCurves


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LATC

61 141 195

.82

.53

.51

Q

LATC

o

K= 10

L= 6

K= 20L= 7 K= 30

L = 8


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Long-Run Average Total Cost

(SATC)1

(SATC)2

(SATC)3

LATC

Rs.

0

Q


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Economies and diseconomies ofscale

Economies of scale refers to thephenomena of decreased per unit cost asthe number of units of production increase.


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The initial investment in capital is diffusedthrough an increase in production, and themarginal cost of producing a good or

service decreases when each additionalunit of production is added.


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Economies of scale means a reduction inthe per unit costs of a product as a firm'sproduction increases.


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Where do Economies of ScaleOccur Most?

Economies of scale tend to occur in industries with highcapital costs in which those costs can be distributedacross a large number of units of production (both inabsolute terms, and, especially, relative to the size of themarket).

A common example is a factory: An investment in machinery is made, and one worker, or unit of

production, begins to work on the machine and produces acertain number of goods. If another worker is added to themachine he or she is able to produce an additional amount ofgoods without adding significantly to the factory's cost of

operation. The amount of goods produced grows significantlyfaster than the plant's cost of operation. Hence, the cost ofproducing an additional good is less than the good before it, andan economy of scale emerges.


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Types of Economies of Scale

Internal Economies of scale

External Economies of scale


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Internal Economies of Scale

These are economies made within a firm as aresult of mass production. As the firm producesmore and more goods, the average cost begin to

fall because of: Technical economiesmade in the actual production of

the good. For example, large firms can use expensivemachinery, intensively.

Managerial economiesmade in the administration ofa large firm by splitting up management jobs andemploying specialist accountants, salesmen, etc.


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Financial economies made by borrowingmoney at lower rates of interest than smallerfirms.

Marketing economiesmade by spreading thehigh cost of advertising on television and innational newspapers, across a large level ofoutput.


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Commercial economies made when buyingsupplies in bulk and therefore gaining a largerdiscount.

Research and development economiesmadewhen developing new and better products.


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Internal Economies of Scale

Technical Economies of Scale

The Law of Increased Dimensions

Cubic law can be applied where cubic volume increases morethan proportionate to surface area

Economies of linked processes Production processes can be linked together with one integrated

plant important in mass production which requires complexmanufacturing processes

Large-scale indivisible units of capital machinery

Capable of high productivity Huge units of capital require a vast output in order to reduce the

average cost per unit

Specialisation and Division of Labour


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Diseconomies of scale

Diseconomies of scale are the forcesthat cause larger firms to produce goodsand services at increased per-unit costs.


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Internal Diseconomies of Scale

These occur when the firm has become too large andinefficient. As the firm increases production, eventuallyaverage costs begin to rise because: The disadvantages of the division of labour take

effect- too many people doing different jobs add tocosts.

Management becomes out of touch with the shopfloor and some machinery becomes over-manned-costs increase.

Decisions are not taken quickly and there is too muchform filling.

Lack of communication in a large firm means thatmanagement tasks sometimes get done twice.

Poor labour relations may develop in largecompanies.


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External Diseconomies of Scale

These occur when too many firms have locatedin one area

Local labour becomes scarce and firms nowhave to bid wages higher to attract and retainnew workers

Land and factories become scarce and rentsbegin to rise

The local traffic infrastructure become congestedand so transport costs begin to rise


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Market structure

the number of firms producing identicalproducts


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Market structure and pricedetermination

Market structure in the basis ofcompetition

Perfect competition

Imperfect competition

Monopoly


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Perfect competition

Large number of producers offer ahomogeneous product to a very largenumber of buyers of the product

Example: stock exchange


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Perfect competition

Features:

Large no. of buyers and sellers

Homogeneous product

Perfect mobility of factors of production Free entry and free exit

Perfect knowledge about the market conditions

No government interference

Absence of collusion and independent decision -making


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Perfect vs. pure competition

Perfect competition minus perfect mobilityand knowledge = pure competition


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Imperfect competition

A number of firms sell identical ordifferentiated products with some controlover the price of their products

Example : jobless recovery. Price ofcandidates post recession.

Types

Monopolistic competition Oligopoly

Duopoly


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Monopolistic competition

many competing producers sell productsthat are differentiated from one another(that is, the products are substitutes, but,

with differences such as branding, are notexactly alike)

Example: restaurant , clothing etc.,


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Oligopoly

A few are sellers

Differentiated or homogeneous products.

Characteristics: Intensive competition

Interdependence of business decisions

Barriers to entry

Examples: Aviation, Communication, etc


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Duopoly

A situation in which two companies own allor nearly all of the market for a given typeof product or service.

Example: visa and master card, politics


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Monopoly

Indian opium that the drug is chieflysupplied to the world Government

monopoly OG&E , Oklahoma Gas & Electric

Company

Indian railway organization Some medicine companies


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Pure Monopoly

exists when a single firm is the sole producer of a

product for which there are no close substitutes

Characteristics Single Seller - a one producer of a specific product

No Close Substitutes - no reasonable alternative products "Price Maker" - the firm exercises considerable control over price

because it is responsible for the quantity supplied.

Totally Blocked Entry - no competitors because of economic,technological, legal obstacles

Advertising - monopolies may or may not advertise monopolist selling luxury good can advertise to increase demand monopolist selling utilities/necessities will not advertise


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Sources and types of monopoly

Legal restrictions

Control over key raw materials

Efficiency Patent rights


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Price determination


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Price discrimination

First degree: to take away the entire consumerssurplus

Second degree: different prices to different

economic class of consumers

Third degree: total output is divided into themarkets and pricing done accordingly to

maximize profit

Normal autos running as share auto. From 1 hecan charge Rs.100 and from next he can take

just Rs.10


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Monopsony, in which there is only onebuyer of a good.

Oligopsony, in which there is a smallnumber of buyers.

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Economies of Scale and Market Structure

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