7. Cost Of Production

Question 1

Define IEOS.

Answer 1

Internal economies of scale are cost savings that accrue directly to the firm from the expansion of the firm’s output, independent if what is happening to other firms.

Question 2

Explain three sources of IEOS with examples.

Answer 2

Bulk Purchase.
- A large firm buys its supplies and raw materials in bulk and can usually obtain a larger discount than the small firms. For example, a garment factory can purchase its textile in bulk directly from the textile mill at a lower cost while an independent tailor will have to obtain his supplies from wholesalers or retailers at a much higher cost. Thus AC of production is lower for larger firms.

Increased Specialization
- If the scale of production is large, there is greater scope for specialization for labour. specialization makes division of labour possible where the production process can be broken down into simpler tasks. Through division of labour, workers become better at performing the repetitive task and there is less time wasted from shifting from one task to another.

Economies of indivisibility
- larger machineries tend to be more technically superior than smaller ones
- BreadTalk large oven

Container Principle
- COP increases less than proportionate to the increase in the output of the firm
- Warehouse

Question 3

Define MES.

Answer 3

The minimum efficient scale is the minimum level of output beyond which there is no more cost savings to be reaped in the LR.

Question 4

Define EEOS

Answer 4

External economies of scale are cost savings enjoyed by a firm due to the expansion of the industry; independent of the firm’s output.

Question 5

Explain three sources of EEOS with examples.

Answer 5

1. Development of infrastructure
   - government and even suppliers might be incentivized to improve the infrastructure such as the development of industrial amenities and transportation network.
2. Development of Research and Development Facilities
   - firms may combine efforts to engage in R&D or government may set up a research and information center to develop better production methods and procedures of high quality
3. Availability of Skilled Labour Force
   -talents are attracted to the area, reduce the cost incurred by the firm in training labour for itself.

Question 6

Define small firms and explain 3 DD factors and 3 SS factors for existence of small firms.

Answer 6

Small firms can be measured by
- turnover
-assets
- no of employees
- mkt share
- mkt capitalization

DD factor
- nature of product (personalized services, hairdressing, law etc)
- consumer preferences (niche market)
- convenience to consumers (groceries, clinics)

SS factor
- DEOS
- lack of finance
- unwillingness t take greater risks or lose control