economies and diseconomies of scale
DESCRIPTION
A2 revision presentation on aspects of economies of scale, diseconomies of scale, economies of scope, minimum efficient scaleTRANSCRIPT
Economies and Diseconomies of Scale - Analysis
A2 Micro – Autumn 2013
Get help from fellow students, teachers and tutor2u on Twitter:
#econ3@tutor2u_econ
Buying economies
Buying in greater quantities usually results in a lower price (bulk-buying) – the use of monopsony power
Technical Use of specialist equipment / bulky units of capital or specialist processes to boost productivity e.g. law of increased dimensions
Risk-bearing Grow a wider range of products and customer markets through diversification to lower market risk for investors
Marketing Spreading a fixed marketing spend over a larger range of products, markets and customers
Network Adding extra customers or users to a network that is already established (e.g. mobile phones)
Financial Larger firms benefit from access to cheaper finance, smaller businesses often credit constrained
Industry An external economy – all competitors benefit – e.g. specialist businesses grouped close together
Internal Economies of Scale
Servers at Google
Retail Scale at Sainsbury’s
Long Run Cost Per Unit
Output
Cost per unit
SRAC1
SRAC2
SRAC3 SRAC4
Internal economies of scale – falling unit costs as the scale of production grows
Long Run Cost Per Unit
Output
Cost per unit
SRAC1
SRAC2
Economies of scale
(increasing returns)
Internal economies of scale – falling unit costs as the scale of production grows
Long Run Cost Per Unit
Output
Cost per unit
SRAC1
SRAC2
Economies of scale
(increasing returns)
SRAC3
Constant returns to scale
Internal economies of scale – falling unit costs as the scale of production grows
Long Run Cost Per Unit
Output
Cost per unit
SRAC1
SRAC2
Economies of scale
(increasing returns)
SRAC3 SRAC4
Constant returns to scale
Internal economies of scale – falling unit costs as the scale of production grows
Long Run Cost Per Unit
Output
Cost per unit
SRAC1
SRAC2
Economies of scale
(increasing returns)
SRAC3 SRAC4
Constant returns to scale
Diseconomies of scale
LRAC
Internal economies of scale – falling unit costs as the scale of production grows
Minimum Efficient Scale (MES)
Output
Cost per unit
LRAC
Economies of scale
(increasing returns)
Constant returns to scale
Diseconomies of scale
The minimum efficient scale is the scale of output where internal economies of scale have been fully exploited
Cost & Price
Output (Q)
Different Shapes of Long Run Average Cost Curves
Low MES, limited scale economies, contestable market
LRAC
Q1
Minimum efficient scale (MES)
Scope for many firms to reach the MES
Cost & Price
Output (Q)
Different Shapes of Long Run Average Cost Curves
Low MES, limited scale economies, contestable market
LRAC
Q1 Output (Q)
High MES, falling LRAC, barriers to contestability
Extensive internal economies of scale leading to lower LRAC
LRAC
Natural Monopoly
Minimum efficient scale (MES)
Scope for many firms to reach the MES
Q1 Q2 Q3 Q4
Falling LRAC for a natural monopoly
Output (Q)
High MES, falling LRAC, barriers to contestability
Extensive internal economies of scale leading to lower LRAC
LRAC
Natural Monopoly
Q1 Q2 Q3 Q4
London Underground
Water & Sewerage Networks
Falling LRAC for a natural monopoly
Output (Q)
High MES, falling LRAC, barriers to contestability
Extensive internal economies of scale leading to lower LRAC
LRAC
Natural Monopoly
Q1 Q2 Q3 Q4
London Underground
Water & Sewerage Networks
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
In this example, increasing the scale of production allows a
move from AC1 to AC2
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
Add in the revenue curve (AR)
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
And the marginal revenue (MR)
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Profit maximising output is at Q1 and the optimum price is P1
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
With economies of scale, the profit maximising price and output changes to P2, Q2
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Profit at price P1
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Profit at price P1
Profit at price P2
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
What are the effects of this for consumer welfare?
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Consumer surplus increases because of the higher output
and lower price
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC2MC2
AR
MR
Q2
P2
Consumer surplus at P2
Falling LRAC for a natural monopoly
Output (Q)
Natural MonopolyCost & Price
LRAC
Falling LRAC for a natural monopoly
Output (Q)
LRMC
Natural MonopolyCost & Price
LRAC
With a natural monopoly, the long run average cost
curve continues to fall over a huge range of
output
Falling LRAC for a natural monopoly
Output (Q)
LRMC
Natural MonopolyCost & Price
LRAC
AR
MR
With a natural monopoly, the long run average cost
curve continues to fall over a huge range of
output
Falling LRAC for a natural monopoly
Output (Q)
LRMC
Profit maximising output is lower than the minimum efficient scale
Cost & Price
LRAC
AR
MR
Q1
P1
Falling LRAC for a natural monopoly
Output (Q)
LRMC
Profit maximising output is lower than the minimum efficient scale
Cost & Price
LRAC
AR
MR
Q1
P1
C1
Falling LRAC for a natural monopoly
Output (Q)
LRMC
Total profit at Q1Cost & Price
LRAC
AR
MR
Q1
P1
C1
Cost & Price
Output (Q)
Long Run Cost Advantages for Existing / Established Businesses
Cost advantage for Firm A over a potential rival Firm B
At output Q1 – firm A has a big cost advantage over a potential rival firm B
Reasons?
Firm B
Firm A
Q1
AC (B)
AC (A)
Cost & Price
Output (Q)
Long Run Cost Advantages for Existing / Established Businesses
Cost advantage for Firm A over a potential rival Firm B
At output Q1 – firm A has a big cost advantage over a potential rival firm B
1. Learning economies2. Vertical integration
3. Lower customer churn4. Monopsony power
Firm B
Firm A
Q1
AC (B)
AC (A)
Learning Economies
Output
Cost(per unit
of output)
LRAC1
B
Economies of Scale
A
LRAC2
Learning economies C
External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry
Science Parks – University Research
Agglomeration Economies – knowledge clusters
External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry
Science Parks – University Research
Agglomeration Economies – knowledge clusters
Granta Park in Cambridge
Agglomeration Clusters in Northamptonshire
Silicon Valley – Oakland, CA
Silicon Roundabout – Tech City
External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry
Output
LRAC1
B
Internal Economies of Scale
A
Cost(per unit
of output)
External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry
Output
LRAC1
B
Internal Economies of Scale
A
Cost(per unit
of output)
LRAC2 (EEoS)
External Economies of Scale
Economies of Scope
Where it is cheaper to produce a range of products rather than specialize in a very limited number
Economies of Scope
Where it is cheaper to produce a range of products rather than specialize in a very limited number
Hypermarkets Amazon Proctor & Gamble
Economies of Scope
Where it is cheaper to produce a range of products rather than specialize in a very limited number
Hypermarkets Amazon Proctor & Gamble
Economies of Scope
Where it is cheaper to produce a range of products rather than specialize in a very limited number
Hypermarkets Amazon Proctor & Gamble
Amazon and Economies of ScopeAmazon launched its groceries range, which includes tea, pasta and biscuits, in July 2010 with little more than 22,000 products. However, it now offers in excess of 150,000 products, from crisps to nappies, which are typically sold in bulk, as it attempts to gobble up sales from the high street
Poor communication within businesses
More difficult to control a larger, more complex business
More frequent machinery & employee breakdown if output & capacity utilisation is too high
Loss of management focus, greater risk of industrial relations problems and possible strikes
Factors which cause the average production cost per unit of a business to increase above the efficient level…for example
Internal Diseconomies of Scale – Rising LRAC
Get help from fellow students, teachers and tutor2u on Twitter:
#econ3@tutor2u_econ