6895131 economies dis economies of scale

8/3/2019 6895131 Economies Dis Economies of Scale

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Economies & Diseconomies

of Scale


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Production and Cost in the Long

Run

The key difference between the short run andthe long run is that there are no diminishingreturns in the long run.

Diminishing returns occur because workersshare a fixed facility. In the long run the firmcan expand its production facility as itsworkforce grows.


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What is scale?

By scale of an enterprise or size of a plant wemean the amount of investment in fixed factorsof production

Costs of production are lower in larger plants

than in smaller ones This is due to economies of large-scale

production The term economies refers to cost advantages

When these economies are over-exploited theresult may be cost disadvantages, i.e.diseconomies


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Economies of Scale

Economies of scale: a situation in which an

increase in the quantity produced decreases the

long-run average cost of production.

Economies of scale refer to cost savings associated

with spreading the cost of indivisible inputs and input

specialization.

When economies of scale are present, the LAC

curve will be negatively sloped.


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Long-run Average Cost

Long-run average cost (LAC) is total cost

divided by the quantity of output when the

firm can choose a production facility ofany

size.

The LAC curve describes the behavior of

average cost as the plant size expands.

Initially, the curve is negatively sloped, thenbeyond some point, it becomes horizontal.


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Long-run Average Cost

When long-run total cost is proportionate to thequantity produced, long-run average cost does notchange as output increases.

The long-run average costcurve is horizontal for7 ormore rakes per hour.

0

12

Averagecost:$perrake

0 7 14 21 28

Output: Rakes per minute

Long-run Average Cost Curve

Cost

Average

Long-run

Total Cost

Long-run

Minute

Rakes per

Output:

LAC

$20.00$703.5

$12.00$847

$12.00$16814

$12.00$33628


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Labor Specialization

In a large operation, each workerspecializes in fewer tasks thus is moreproductive than his or her counterpart in a

small operation. Higherproductivity (more output per worker)

means lowerlabor costs per unit of output,thus lower production costs (ever-decreasing

average cost).


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Minimum Efficient Scale

The minimum efficient scale describes the

output at which economies of scale are

exhausted and the long-run average cost

curve becomes horizontal.

Once the minimum efficient scale has been

reached, an increase in output no longer

decreases the long-run average cost.


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Diseconomies of Scale

A firm experiences diseconomies of scale

when an increase in output leads to an

increase in long-run average costthe LAC

curve becomes positively sloped.

Diseconomies of scale may arise for two

reasons:

Coordination problems Increasing input costs


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Diseconomies of Scale

After firm has reached its efficient scale, further

in creases in number of workers will lead to

inefficiency

Co-ordination of different processes becomesdifficult and decision-making process becomes

slow

Supervision of workers becomes difficult,

management problems get out of hand with

adverse effects on managerial efficiency


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Types of Economies of Scale

External Economies- Economies available to all firms in the industry.- For eg. Construction of roads, railways in an

area reduces costs for all firms in that area- Discovery of a new technique, rise of industries

using by-products, availability of skilled labourthrough the establishment of special technicalschools

- External economies usually occur when anindustry is heavily concentrated in a particulararea


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Internal Economies of Scale

Internal economies are available to a particular firm andgive it an advantage over other firms engaged in theindustry

Arise from the expansion of the size of a particular firm

From a managerial point of view internal economies aremost important as they can be effected by managerialdecisions of an individual firm to change its size/scale

Internal economies arise due to a firms own expansion

while external economies arise due to expansion ofsome other industry or due to some external factor


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Types of Internal Economies

Labour Economies

-Reduction in labour costs per unit due toincreasing division/specialisation of labour

-Arise due to increase in the skill of workers andsaving of time involved in changing from oneoperation to another

-Many operations may be performed mechanicallyrather than manually

-Economies are maximum where products arecomplex and the manufacturing processes canbe sub-divided


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Technical Economies

-Derived from the use of scientific processes andmachines that a large production firm can afford

Managerial Economies-With the increase in the size of a firm, the

efficiency of management increases because ofgreater specialisation in managerial staff

-Experts in a large firm can be hired to look aftervarious divisions like purchasing, sales,production, financing, personnel


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Marketing Economies

-A large firm can obtain economies in purchasing

and sales as it has bulk requirements and can

hence get better terms-It gets the advantage of prompt deliveries, careful

attention and special facilities from its suppliers

-A large firm can also spread its advertising costover bigger output


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Economies of Risk-spreading

-Larger size of business, greater scope for

spreading of risks through diversification

-Diversification can be either of products or

of markets

6895131 economies dis economies of scale

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