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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