4.1.4.5 ECONOMIES AND DISECONOMIES OF SCALE

What is the equation for TC?

Total fixed costs + Total variable costs

What is the equation for ATC?

Total costs / Quantity

Draw returns vs cost curves

What is the relationship between marginal cost, average fixed cost, average variable cost and average total cost

Explain how "factor prices" and "productivity" affect costs and choices of factor inputs?

High factor prices raises production costs

• FC = stay fixed

• VC = change with output

• TC = FC + VC (so will be above)

Where does the MC cut through?

The lowest point of the ATC curve

Define economies of scale

As output increases, long run average cost falls

Define economies of scale

As output increases, long run average costs falls

Define internal economies and diseconomies of scale

Changes in the long run average costs of production resulting from changes in the size or scale of a firm or plant

Define external economies of scale

A fall in long run average costs of production resulting from the growth of the market or industry of which the firm is a part of

Define external diseconomies of scale

An increase in long run average costs of production resulting from the growth of the market or industry of which the firm is a part of

Is returns to scale a long or short run theory? Is it a production or cost theory?

Returns to scale is a long term production theory

Is economies of scale a long or short run theory? Is it a production or cost theory?

Economies of scale are a long run cost theory

Explain the diagram

Define the short run in micro?

When one factor of production is fixed

Define long run in micro?

All factors of production are variable

What is the minimum efficient scale?

This is the lowest level of output at which the firm minimizes its long run average costs

Define maximum efficient scale?

This is the highest level of output a firm can produce while still maintaining its lowest possible average cost

In the long run, a firm can move from one short run cost to another - which diagram is this?

Lots of small SRAC curves inside a big LRAC curve

Give 6 examples of internal economies of scale

1. Technical economies

2. Purchasing economies (bulk buying)

3. Managerial economies

4. Financial economies

5. Risk bearing economies from diversification

6. Network economies

What are technical economies?

Large businesses can invest in specialised, high capacity machinery, assembly lines or AI

What are purchasing economies?

Large companies negotiate cheaper bulk rates for goods, when buying in massive quantities

What are managerial economies?

As a firm expands, it can afford to hire dedicated, specialist managers

What are financial economies?

Large firms are viewed as lower risk by banks and financial markets

What are risk-bearing economies?

Large companies can diversify their product lines or enter multiple markets to absorb shock if one product fails

What are network economies?

Fixed marketing costs (eg. national TV commercials) can be spread over a much larger volume of sales

Give some examples of external economies of scale

• as an insides grows in an areas, workers with specific skills move there

• a large industry attracts suppliers who compete on prices/delivery

• when an industry expands, governments/developers often build defected roads /rail link/communication networks

Differences between internal and external economies of scale

Give a real world example of when a whole industry has grown which causes AC of production to decrease

Silicon Fen (UK Tech Industry around Cambridge)

AC falls due to:

• skilled labor pool

• specialized suppliers

• knowledge spillovers

So in Silicon Fen - what happens to the LRAC curve?

The entire LRAC curve shifts downwards for every tech firm operating in Cambridge - purely due to the scale of the surrounding industry

What's the minimum efficient scale?

The smallest level of output at which a firm can achieve the LRAC

(the start of the flat bottom of the LRAC)

What the maximum firm size?

The upper limit of how large a single organization can or will grow before inefficiencies outweigh further benefits

How does scale affect the ability of a firm to benefit from economies of scale?

Large businesses can divide high fixed costs across more units, lowering the average cost per unit (specialization of labor, technical efficiencies, bargaining power)

How does market structure affect the ability of a firm to benefit from economies of scale?

For example, in a Monopoly, the LRAC falls continuously across the entire market demand

What are the 2 ways the LRAC can be skewed?

• to the left

• to the right

If LRAC is skewed to the left - what does this mean?

This means the minimum efficient scale is reached at a very low level of output

If LRAC is skewed to the right - what does this mean?

This means that average costs continue to fall over a very long range of output

Smaller businesses tend to be skewed to the left - why?

Smaller businesses rely heavily on labor rather than expensive machinery of factories

Larger businesses tend to be skewed to the right - why?

Large industries require massive initial capital investments in factories, technology and infrastructure