Economies & Diseconomies of Scale

Question 1

Internal Economies of Scale

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Answer 1

Internal EoS: Occur when firm becomes larger, AC of production fall as output rises

• Risk-Bearing: Firm becomes larger, can expand their production range, spreading the cost of uncertainty. If one part unsuccessful, other parts to fall back on
• Managerial: Larger firms able to specialise & divide their labour, can employ specialist managers & supervisors, lowering average costs
• Financial: Banks willing to lend more cheaply to larger firms, deemed less risky, larger firms can take advantage of cheaper credit
• Purchasing: Larger firms can bulk-buy, each unit will cost less. E.g supermarkets have more buying power, can negotiate better deals
• Technological: Larger firms can afford to invest in advanced & productive machinery & capital, lowering AC
• Marketing: Larger firms can divide their marketing budgets across larger outputs, so AC of advertising per unit is less than smaller firm

Question 2

External Econonmies of Scale

Answer 2

External Economies of Scale: Advancements within the industry as a whole, which beinift an individual firm
- E.g local roads improved, so transport costs for the local industries fall
- More training facilities or more research and development, lower AC for firms in local area

Question 3

Diseconomies of Scale:

Answer 3

Diseconomies of Scale: Occur when output passes a certain point & AC start to increase per extra unit of output produced

• Control: Becomes harder to monitor how productive workforce is as firm gets larger
• Coordination: Harder & complicated to coordinate every worker, when there is lots of employees
• Communication: Workers may start to feel alienated & excluded as firm
  grows, leads to falls in productivity & increases AC, as they lose motivation

Question 4

Relationship Between Returns to Scale & Economies/Diseconomies of Scale

Answer 4

• RtS increases when output increases by a greater proportion to the increase in inputs
• E.g, if input = 2, & output = 4, there is increasing RtS & Economies of Scale as factor inputs become more productive
• If input = 2, output = 1.5 there are decreasing RtS & Diseconomies of Scale as factor inputs become less productive.

Question 5

L-Shaped LRAC Curve

Answer 5

• Diagram shows the relationship between SRAC curve & LRAC curve
• LRAC curve envelopes SRAC curve, is always equal or below SRAC curve
• LRAC shifts when there are external EoS (E.g industry growth)
• SRAC falls at first, then rises, due to diminishing returns
• In long run, costs change due to economies & diseconomies of scale
• If SRAC = LRAC, firm operates where it can vary all factor inputs.
• The L-shape curve suggests that to begin with, costs per unit fall as output increases, due to
  EoS
• Even if there are DEoS within firm, (e.g managerial costs), they are offset by EoS gained (e.g technology, production)
• Means that in LR, costs continue to fall, even if the pace of falling output costs slows (shown by the flat part of curve)

Question 6

Long Run Average Cost Curve:

Answer 6

• Initially, AC falls as firms take advantage of EoS, meaning AC falls as output increases
• After optimum level of output, where AC is at its lowest, AC rises due to DEoS

Question 7

Minimum Effecient Scale

Answer 7

Minimum Efficient Scale: Lowest point of LRAC, where optimum level of output is since costs are lowest, & EoS of production
have been fully utilised