economies and diseconomies of scale -...
TRANSCRIPT
Economies and Diseconomies of Scale
Buying economies
Buying in greater quantities usually results in a lower price (bulk-buying)
Technical Use of specialist equipment / bulky units of capital or specialist processes to boost productivity
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 are often credit constrained
Industry An external economy – all competitors benefit – e.g. specialist businesses grouped close together
Internal Economies of Scale
Servers at Google
Long Run Cost Per Unit
Output
Cost per unit
SRATC1
SRATC2
SRATC3 SRATC4
Internal economies of scale – falling unit costs as the scale of production grows
Long Run Cost Per Unit
Output
Cost per unit
SRATC1
SRATC2
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
SRATC1
SRATC2
Economies of scale
(increasing returns)
SRATC3
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
SRATC1
SRTAC2
Economies of scale
(increasing returns)
SRATC3 SRATC4
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
SRATC1
SRATC2
Economies of scale
(increasing returns)
SRATC3 SRATC4
Constant returns to scale
Diseconomies of scale
LRATC
Internal economies of scale – falling unit costs as the scale of production grows
Minimum Efficient Scale (MES)
Output
Cost per unit
LRATC
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
LRATC
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 LRATC,
barriers to contestability
Extensive internal economies of scale leading to lower LRATC
LRATC
Natural Monopoly
Minimum efficient scale (MES)
Scope for many firms to reach the MES
Q1 Q2 Q3 Q4
Falling LRATC for a natural monopoly
Output (Q)
High MES, falling LRATC,
barriers to contestability
Extensive internal economies of scale leading to lower LRATC
LRATC
Natural Monopoly
Q1 Q2 Q3 Q4
London Underground
Water & Sewerage Networks
Falling LRATC for a natural monopoly
Output (Q)
High MES, falling LRATC,
barriers to contestability
Extensive internal economies of scale leading to lower LRATC
LRATC
Natural Monopoly
Q1 Q2 Q3 Q4
London Underground
Water and Sewage Networks
Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
ATC1
ACT2
MC1
MC2
In this example, increasing the scale of production allows
a move from ATC1 to ATC2
Falling LRATC for a natural monopoly
Output (Q)
Natural Monopoly Cost & Price
LRATC
Falling LRATC for a natural monopoly
Output (Q)
LRMC
Natural Monopoly Cost & Price
LRATC
With a natural monopoly, the long run average cost
curve continues to fall over a huge range of
output
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
ATC
(B)
ATC
(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 economies 2. Vertical integration
3. Lower customer churn 4. Monopsony power
Firm B
Firm A
Q1
ATC
(B)
ATC
(A)
Poor communication within businesses
More difficult to control a larger, more complex business
More frequent machinery and employee breakdown if output and capacity utilization 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 LRATC