economies of scaleppt

Economies of ScaleEconomies of Scale


The advantages of large scale production that The advantages of large scale production that result in lower unit (average) costs (cost per result in lower unit (average) costs (cost per unit)unit)

AC = TC / QAC = TC / Q Economies of scale – spreads total costs over a Economies of scale – spreads total costs over a

greater range of outputgreater range of output


Internal – advantages that arise as a result of Internal – advantages that arise as a result of the growth of the firmthe growth of the firm TechnicalTechnical CommercialCommercial FinancialFinancial ManagerialManagerial Risk BearingRisk Bearing


External economies of scale – the advantages firms External economies of scale – the advantages firms can gain as a result can gain as a result of the growth of the industry – normally associated of the growth of the industry – normally associated with a particular areawith a particular area

Supply of skilled labourSupply of skilled labour ReputationReputation Local knowledge and skillsLocal knowledge and skills InfrastructureInfrastructure Training facilitiesTraining facilities


CapitalCapital LandLand LabourLabour OutputOutput TCTC ACAC

Scale AScale A 55 33 44 100100

Scale BScale B 1010 66 88 300300

•Assume each unit of capital = £5, Land = £8 and Labour = £2•Calculate TC and then AC for the two different ‘scales’ (‘sizes’) of production facility•What happens and why?

Economies of ScaleEconomies of ScaleCapitalCapital LandLand LabourLabour OutputOutput TCTC ACAC

Scale AScale A 55 33 44 100100 5757 0.570.57

Scale BScale B 1010 66 88 300300 164164 0.540.54

•Doubling the scale of production (a rise of 100%) has led to an increase in output of 200% - therefore cost of production •PER UNIT has fallen•Don’t get confused between Total Cost and Average Cost•Overall ‘costs’ will rise but unit costs can fall•Why?


Internal: TechnicalInternal: Technical SpecialisationSpecialisation – large organisations – large organisations

can employ specialised labourcan employ specialised labour Indivisibility of plantIndivisibility of plant – machines can’t be broken down to – machines can’t be broken down to

do smaller jobs!do smaller jobs! Principle of multiplesPrinciple of multiples – firms using more than one machine – firms using more than one machine

of different capacities - more efficientof different capacities - more efficient Increased dimensionsIncreased dimensions – bigger containers can reduce – bigger containers can reduce

average costaverage cost


Indivisibility of Plant:Indivisibility of Plant: Not viable to produce products Not viable to produce products

like oil, chemicals on small scale – need large like oil, chemicals on small scale – need large amounts of capitalamounts of capital

Agriculture – machinery appropriate for large Agriculture – machinery appropriate for large scale work – combines, etc.scale work – combines, etc.


Principle of Multiples:Principle of Multiples: Some production processes Some production processes

need more than one machineneed more than one machine Different capacitiesDifferent capacities May need more than one machine to be fully May need more than one machine to be fully

efficientefficient

Economies of ScaleEconomies of Scale Principle of Multiples: e.g.Principle of Multiples: e.g.

Machine AMachine A Machine BMachine B Machine CMachine C Machine DMachine D

Capacity = 10 Capacity = 10 per hourper hour




Cost = £100 per Cost = £100 per machinemachine



Cost = £200Cost = £200

per machineper machine

Company A = 1 of each machine, output per hour = 10Total Cost = £500AC = £50 per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60Total Cost = £1750AC = £29.16 per unit

Economies of ScaleEconomies of ScaleIncreased Dimensions: e.g.

5m

2m

2m

Transport container = Volume of 20m3

Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = £600 per journeyAC = £30m3

4m

10m

4m

Transport Container 2 = Volume 160m3

Total Cost = £1800 per journeyAC = £11.25m3


CommercialCommercial Large firms can negotiate favourable prices as Large firms can negotiate favourable prices as

a result a result of buying in bulkof buying in bulk

Large firms may have advantages in keeping Large firms may have advantages in keeping prices higher because prices higher because of their market powerof their market power


FinancialFinancial Large firms able to negotiate cheaper finance Large firms able to negotiate cheaper finance

dealsdeals Large firms able to be more flexible about Large firms able to be more flexible about

finance – share options, rights issues, etc. finance – share options, rights issues, etc. Large firms able to utilise skills of merchant Large firms able to utilise skills of merchant

banks to arrange financebanks to arrange finance


ManagerialManagerial Use of specialists – accountants, Use of specialists – accountants,

marketing, lawyers, production, human marketing, lawyers, production, human resources, etc.resources, etc.


Risk BearingRisk Bearing DiversificationDiversification Markets across regions/countriesMarkets across regions/countries Product rangesProduct ranges R&DR&D


Minimum Efficient Scale – the point at 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 of an individual plant within the industry yields no significant unit cost benefits


Unit Cost

Output

Scale A

Scale B

LRAC

MES

82p

54p

Diseconomies of ScaleDiseconomies of Scale

The disadvantages of large scale production that The disadvantages of large scale production that can lead to increasing average costscan lead to increasing average costs Problems of managementProblems of management Maintaining effective communicationMaintaining effective communication Co-ordinating activities – often across Co-ordinating activities – often across

the globe!the globe! De-motivation and alienation of staffDe-motivation and alienation of staff Divorce of ownership and controlDivorce of ownership and control

economies of scaleppt

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