economies of scale_2
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Economies of Scale
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Economies of Scale
The advantages of large scaleproduction that result in lower unit
(average) costs (cost per unit) AC = TC / Q
Economies of scale spreads total
costs over a greater range ofoutput
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Economies of Scale
Internal advantages that arise asa result of the growth of the firm
Technical
Commercial
Financial
ManagerialRisk Bearing
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Economies of Scale
External economies of scale theadvantages firms can gain as a resultof the growth of the industry normallyassociated with a particular area
Supply of skilled labour
Reputation
Local knowledge and skills Infrastructure
Training facilities
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Economies of ScaleCapital Land Labour Output TC AC
Scale A 5 3 4 100
Scale B 10 6 8 300
Assume each unit of capital = 5, Land = 8and Labour = 2
Calculate TC and then AC for the two differentscales (sizes) of production facilityWhat happens and why?
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Economies of ScaleCapital Land Labour Output TC AC
Scale A 5 3 4 100 57 0.57
Scale B 10 6 8 300 164 0.54
Doubling the scale of production (a rise of 100%) has ledto an increase in output of 200% - therefore cost of
productionPER UNIT has fallenDont get confused between Total Cost and Average CostOverall costs will rise but unit costscan fallWhy?
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Economies of Scale
Internal: Technical
Specialisation large organisations
can employ specialised labour Indivisibility of plantmachines cant be
broken down to do smaller jobs!
Principle of multiples firms using more
than one machine of different capacities -more efficient
Increased dimensions bigger containerscan reduce average cost
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Economies of Scale
Indivisibility of Plant:
Not viable to produce products
like oil, chemicals on small scale need large amounts of capital
Agriculture machinery
appropriate for large scale work combines, etc.
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Economies of Scale
Principle of Multiples:
Some production processes
need more than one machine
Different capacities
May need more than one machineto be fully efficient
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Economies of Scale Principle of Multiples: e.g.
Machine A Machine B Machine C Machine D
Capacity =
10 per hour
Capacity =
20 per hour
Capacity =
15 per hour
Capacity =
30 per hourCost = 100per machine
Cost = 50per machine
Cost = 150per machine
Cost = 200
per machine
Company A = 1 of each machine, output per hour = 10
Total Cost = 500AC = 50 per unitCompany B = 6 x A, 3 x B, 4 x C, 2 x D output per hour = 60Total Cost = 1750AC = 29.16 per unit
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Economies of ScaleIncreased Dimensions: e.g.
5m
2m
2m
Transport container = Volume of 20m3
Total Cost: Construction, driver, fuel,maintenance, insurance, road tax =600 per journey
AC = 30m3
4m
10m
4m
Transport Container 2 = Volume 160m3
Total Cost = 1800 perjourneyAC = 11.25m3
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Economies of Scale
Commercial
Large firms can negotiate
favourable prices as a resultof buying in bulk
Large firms may have advantages
in keeping prices higher becauseof their market power
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Economies of Scale
Financial
Large firms able to negotiate
cheaper finance deals Large firms able to be more
flexible about finance share
options, rights issues, etc. Large firms able to utilise skills ofmerchant banks to arrange finance
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Economies of Scale
Managerial
Use of specialists accountants, marketing,lawyers, production, human
resources, etc.
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Economies of Scale
Risk BearingDiversification
Markets across regions/countries
Product ranges
R&D
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Economies of Scale
Minimum Efficient Scale the pointat which the increase in the scale of production
yields no significant unit cost benefits
Minimum Efficient Plant Size the
point where increasing the scale of production ofan individual plant within the industry yieldsno significant unit cost benefits
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Economies of Scale
Unit Cost
Output
Scale A
Scale B
LRAC
MES
82p
54p
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Diseconomies of Scale
The disadvantages of large scaleproduction that can lead to
increasing average costs Problems of management
Maintaining effective communication
Co-ordinating activities often across
the globe! De-motivation and alienation of staff
Divorce of ownership and control