Economies and diseconomies of scale Flashcards
(7 cards)
What is the difference between internal and external economies of scale?
1)Internal Economies of Scale: Cost advantages that a firm experiences as it increases its production scale, leading to a reduction in average costs. These arise from within the firm and include factors like technical improvements, managerial efficiencies, and financial advantages
2)External Economies of Scale: Cost benefits that occur outside a firm but within an industry, leading to a reduction in average costs as the industry expands. These include factors like improved infrastructure, supplier specialization, and technological advancements
Example: A company investing in new machinery to increase production efficiency experiences internal economies of scale. Conversely, if the government builds better roads that reduce transportation costs for all firms in the industry, this is an external economy of scale.
Factors that contribute to diseconomies of scale?
1)Communication Challenges: In larger organizations, information may not flow as efficiently, leading to misunderstandings and delays.
2)Coordination Difficulties: Managing multiple departments or locations can result in duplicated efforts and inefficiencies.
3)Control Issues: Ensuring that all parts of the organization align with the firm’s objectives becomes more complex, potentially leading to inconsistent practices.
4)Morale and Motivation: As firms expand, employees may feel less connected to the organisation, leading to decreased motivation and productivity.
What is the relationship between returns to scale and economies or diseconomies of scale?
Returns to scale refer to how output changes in response to proportional changes in all inputs:
• Increasing Returns to Scale: Output increases more than proportionally to input increases, often due to internal economies of scale
• Constant Returns to Scale: Output increases proportionally to input increases, indicating no change in efficiency
• Decreasing Returns to Scale: Output increases less than proportionally to input increases, often due to diseconomies of scale
Example: A firm doubling its inputs and more than doubling its output experiences increasing returns to scale. If output less than doubles, it experiences decreasing returns to scale.
How do economies and diseconomies of scale relate to the shape of the long-run average cost curve?
The long-run average cost (LRAC) curve reflects the lowest possible cost for each output level when all inputs are variable:
• Downward Sloping (Economies of Scale): Indicates decreasing average costs as output increases, due to economies of scale.
• Upward Sloping (Diseconomies of Scale): Indicates increasing average costs as output increases, due to diseconomies of scale.
• Flat or L-Shaped: Suggests constant or minimal changes in average costs, indicating constant returns to scale.
Example: A U-shaped LRAC curve shows economies of scale at first (downward slope) and diseconomies of scale later (upward slope).
What is the L-shaped long-run average cost curve?
An L-shaped LRAC curve suggests that a firm experiences continuous economies of scale, with average costs decreasing as output increases and then leveling off, rather than increasing. This implies that the firm can expand indefinitely without experiencing diseconomies of scale.
Example: Industries with high fixed costs and low variable costs, like utilities, often exhibit L-shaped LRAC curves.
What is the concept of the minimum efficient scale of production?
The minimum efficient scale (MES) is the smallest output level at which a firm can produce at the lowest average cost. At this point, the firm has fully exploited all economies of scale available to it.
Example: If a factory’s average cost decreases as it increases production up to 1,000 units, and then remains constant, the MES is 1,000 units
Factors causing economies of scales
1) Risk bearing
2) Managerial
3) Technical
4) Marketing purchasing
5) Financial
