2.6 - Production and Economies of Scale

role of producers (5)

• make G/S

• make a profit if privately owned

• combine factors of production to produce G/S

• responsible for supply and therefore influence market prices

• employ and pay workers to enable them to buy G/S

who are individual producers, firms, and government producers?

• individuals - producers of non-market goods, e.g. cleaning, babysitting, etc. May be self-employed / produce market goods, e.g. traders, joiners, plumbers, etc.

• firms - vary from small businesses to MNCs (multi-national corporations). can sell on a local, national or global scale

• governments - provide different services, e.g. policing and defence - not provided by private sector as people wouldn’t be willing to pay for something they don’t directly consume

define production

the total output of G/S produced by a firm / industry in a period of time

how can production be increased? (2)

• using more factors of production

• increasing productivity of existing factors of production

benefits of increased production (6)

• increased employment

• increased profits for firm / industry

• economies of scale

• increased market share

• economic growth

• improved standard of living - consumers have more G/S to buy

define productivity

a measure of the degree of efficiency in the use of factors of production in the production process

Productivity is measured in terms of ______ per unit of _____ (i.e. per ______).

output, input, worker

formula for productivity

total output / total input

how can productivity be improved? (3)

• investment in equipment to improve machinery quality and new tech

• improved education and training to improve skills and knowledge of workers

• specialisation of workers in the production process

benefits of higher productivity for workers (2)

• may be rewarded with higher wages, increasing their standard of living

• may have greater job security - firms producing higher output and have greater continuity

benefits of higher productivity for firms (3)

• higher output - firms achieve higher sales. may increase market share if other firms are not expanding

• lower average costs for firms - they benefit from economies of scale. may make firm more competitive - may charge lower prices to consumers

• higher profits for firms - higher sales and lower average costs. profits can be invested, e.g. into new machinery and equipment

benefits of higher productivity for government and the economy (3)

• increased total output in economy leads to economic growth - one of the government’s macroeconomic objectives

• as firms produce more output, and labour becomes more productive, this can create jobs and reduce unemployment

• if firms can be more price competitive, they may export more G/S, improving trade

drawbacks of higher productivity (2)

• firms replace labour with machinery / equipment, increasing unemployment, leading to lower income tax revenue for the government, and an increase in welfare benefits

• greater international competitiveness may cause other nations to retaliate, e.g. place a tariff / tax on our exports. this could lead to a fall in demand for exports and a fall in production from exporting firms. this would reduce economic growth.

what are the types of costs? (2)

• variable costs - expenses that change depending on how much a business produces, e.g. packaging, raw materials

• fixed costs - expenses that remain the same no matter how much a business produces, e.g. salaries, advertising

what is the definition and formula of total variable costs?

• costs of producing an item which vary with output

• TVC = VC per unit x output

what is the formula of total costs?

TC = TFC + TVC

what is the definition and formula of average costs?

• the cost of producing a unit

• AC = TC / quantity

what is the definition and formula of total revenue?

• total income from the sale of G/S

• TR = price x quantity

what is the definition and formula of average revenue?

• revenue per unit sold

• AR = TR / quantity

what is the formula for profit / loss?

profit / loss = TR - TC

when do profits and losses occur?

• profit occurs when TR > TC

• loss occurs when TC > TR

importance of cost to producers (3)

• impacts whether firms make profits / losses - profits are important, e.g. bonuses to managers, dividends to shareholders, reinvest into growth / expansion

• cost of production affects supply of G/S - if costs fall, supply curve will shift

• all firms aim to keep costs low to make / increase profits

importance of revenue to producers (4)

• needed to make a profit / survive in early stages - more revenue helps a firm cover their costs

• may encourage investors to invest more money, aiding growth and expansion

• easier to secure loans and finance as more likely to afford repayments - financial economies of scale

• stakeholders have greater confidence in the firm, e.g. retailers likely to buy from successful firms as they continue to supply goods

importance of profit to producers (4)

• important in a market economy - high profits acts as an incentive to move scarce resources into making that G/S

• profits are a source of finance - can be reinvested, fuelling growth and expansion

• can reward shareholders with higher returns on their investments (dividends)

• in the short run, a loss won’t have a big impact. if the loss is sustained, this will have the opposite role to profit - producer may be forced to close

define economies of scale

the cost advantages a firm can gain by increasing the scale of production, leading to a fall in average costs

define internal economies of scale

occurs as a result of growth of the firm itself, leading to cost savings and resulting in falling average costs

types of internal economies of scale (9) and explain each one

• purchasing - large firms can negotiate discounts when bulk-buying raw materials, reducing average costs

• marketing - large firms can spread its advertising and marketing budget over a larger output, reducing average costs

• managerial - large firms can afford to employ specialist managers who are paid higher salaries - cost is spread over a larger output, reducing ACs

• technical - large firms can purchase expensive specialist equipment; costs can be spread over a larger output, reducing ACs

• financial - large firms can borrow money from banks more easily at lower interest rates; they are seen at less risk of not re-paying loans - greater sources of new finance to reinvest

• division of labour - large firms can divide work into separate tasks. workers become specialised in the production process, resulting in higher output

• risk-bearing - large firms can expand to sell a range of G/S, reducing risks of failure and increasing output, reducing average costs

• R+D - large firms can afford to have their own R+D department, allowing them to stay ahead of their competitors

• increased dimension - large firms can ship more in bigger containers, reducing transportation costs; shipping more for same amount

define external economies of scale

economies of scale that a firm benefits from as a member of an industry / because of its location - available to all firms in an industry regardless of size

types of external economies of scale - explain each one (4)

• improved transport links - e.g. better roads, means lower transport costs

• educational - local colleges and univs offer R+D facilities for fees. Costs fall and firms get more skilled labour

• suppliers - likely to locate near main producers; thus, transport costs are lower, and production time also falls

• location - a good reputation area attracts more skilled labour

drawbacks of economies of scale - explain each one (3)

• diseconomies of scale - as a business expands in the long run, the average costs may rise

• lack of co-operation - workers feel isolated / unappreciated in a large firm. lower loyalty and motivation leads to lower productivity and a rise in average costs for labour

• lack of direction / co-ordination - when the workforce gets bigger, it’s harder for managers to monitor workers and communicate effectively. this leads to lower labour productivity, so a rise in average costs for labour

benefits of economies of scale (2)

• increased efficiency, leading to a competitive advantage in a market

• can gain higher profits / lower prices which can increase market share