Theory of the Firm

Economies of Scale

1: Specialisation of labour​

Each worker specialises in performing certain tasks, increasing productive efficiency andallowing output to be produced at a lower AC​

2: Specialisation of management​

Managers can specialise in a certain area, increasing productive efficiency and allowingoutput to be produced at a lower AC​

3: Bulk buying of inputs (factors of production)​

As quantities of inputs purchased increase, the price per unit drops​

4: Financing​

Larger firms may have lower interest rates, thus reducing costs per unit of output​​

5: Spreading of certain costs, such as marketing, over large volumes​

Thus resulting in lower AC

Diseconomies of scale​

1: Coordination and monitoring difficulties​

Managers struggle to monitor a larger workforce, resulting in growing inefficiencies andincreasing AC as the firm expands.​

2: Communication difficulties​

Various components of the firm may less easily communicate as the firm grows increasinginefficiency and increasing AC.​

3: Poor worker motivations​

Workers may feel less connected to the firm and management in a large firm, they becomeless productive, increasing AC

Perfect Competition

• Many small firms​

• Homogeneous products (perfect substitutes)​

• No market power (firms are price takers)​

• No barriers to entry or exit​

• Perfect information​

• Perfect factor mobility

Perfect Competition Diagram