Revenue and Cost Concepts -- Firms and Decisions

Explicit Cost definition

Cost to acquire factors of production that are not owned by the firm

Implicit Cost Definition

Opportunity cost of using factors of production that are owned by the firm

Internal Economies of Scale definition

Cost savings leading to a fall in unit costs arising from a firm’s decision to increase its scale of production/expand

Technical EOS

Specialisation and division of operations allows workers to focus on specific roles and accumulate more skills and knowledge, increasing productivity and lowering average cost

Administrative/Managerial EOS

Expansion allows a firm to hire additional professionals with specific areas of expertise. This enhances specialization, increasing productivity and reducing average cost.

Marketing EOS Factor 1

Spreading of overhead: Advertising costs do not vary with a firm’s output. Larger firms with a larger output can better spread out this overhead cost. hence, due to their larger output average cost will not be lower compared to smaller firms with lower output

Marketing EOS Factor 2

Bulk Buying: Larger firms also have greater bargaining power due to the ability to buy in bulk. They are able to negotiate with suppliers for discounts on their bulk purchases, lowering the unit cost of production

Internal Diseconomies of Scale definition

Cost dissaving arising from a firm’s decision to increase its scale of production/over expand above the MED

Managerial DEOS

As firms get larger, there tend to be more rules, regulations, and standard procedures. This causes excessive ‘red tape’ and a slowdown in decision-making, thus decreasing efficiency. Coordination between departments and more supervision will be needed, increasing average costs.

Larger firms may also have workers with poor motivation and low morale due to less interactions with their immediate superiors to air any workplace grievances, causing higher employee turnover. This decreases productivity and increases average cost. Firms may also have to invest more in training new workers.

Marketing DEOS

Decision makers in large firms are usually distanced from the customer base, creating a gap in the information provided to customers. Additional spending on marketing may then be needed to close the gaps, increasing the firm’s average costs.

External Economies of Scale (eEOS) definition

A reduction in unit cost arising from the industry’s expansion, with the firm’s own output remaining unchanged.

Economies of Concentration

Concentration of firms in a specific geographical area allows them to benefit from sharing a large pool of skilled labour, developments and improvements in infrastructure, and the provision of supporting services. The concentration of firms operating in the same industry also gives the area a reputation as a place of expertise for that specific industry, Firms will have a lesser need to engage in advertising, decreasing their average cost.

Economies of Information

Firms can enjoy savings from the sharing of knowledge and information by spreading out R&D costs through joint research facilities and cooperating to develop common industry standards.

Less duplication and wastage of research efforts can also occur due to the sharing of knowledge.

External Diseconomies of Scale (eDOS) definition

An increase in unit cost arising from the industry’s expansion, with the firm’s own output remaining unchanged

eDEOS Greater competition for commonly used factors of production

As the industry expands, firms face greater competition for a limited pool of resources (land, labour, raw materials) and respond by increasing the prices they pay for them. This raises the average cost of production.

eEOS Over-concentration

Over-usage of shared infrastructure can wear the infrastructure out or cause congestion, decreasing efficiency and increasing production costs