Costs and economies of scale

What is the average costs

• Total cost per unit of output

• Total cost/ output

What is the average fixed cost

Total fixed cost per unit of output

What is the average variable cost

Total variable cost per unit pf output

What is diminishing returns

Addition of a variable factor to a fixed factor results in a fall in marginal product

What is a fixed costs

Business expense that does not vary directly with the level of output

What is the marginal costs

The change in total costs from increasing output by one extra unit

Short run

• At least one of the factor inputs is fixed (usually capital or land)

• In the short run businesses are constrained with fixed and varibale costs

Long run

• All factors of production are variable and the scale of production can also change allowing the firm to benefit from economies of scale

Examples of fixed cost

• Insurance- Fixed costs don’t vary as the level of output changes in short run

• Software- Fixed costs has to be paid whatever the lev of scales achieved

• Rental agreement- The higher the level of fixed costs in a business the higher must be the output in order to break even

What is total variable costs

• The total variable cots increase as the businesses produces more

• variable cost per unit x output

what is total costs

• It is all cost incurred by a business

• Total variable costs + total fixed cost

What are internal economies of scale

• Arises when a firm grows larger

• The firm has control over its own decisions which can lead to internal economies of scale

What are external economies of scale

Arises when an entire industry expands not just one business and the firm benfits

The internal economies of scale

• Purchasing

• Technical

• Marketing

• Management

• Financial

Purchasing economies of scale

• A business is likely to be able to negotiate a lower cost for purchasing raw materials and perhaps even capital items the more it purchases

• Somtines known as bulk buying

Technical economies of scale

A business that is producing many priducts is likely to be able to buy better technology which can reduce average costs

Technical economies of scale

A business that is producing many priducts is likely to be able to buy better technology which can reduce average costs

Marketing economies of scale

• A business that is producing more is likely to be able to afford mass marketing promotion

• Likely to have a lower average cost per potential customer

Management economies of scale

Many small business cannot afford to employ specialist managers whereas larger business can afford specialist managers who are likely to be more effiient and therefore have a lower avergae costs

Financial economies of scale

A larger business is likely to be able to negotiate lower financial cost such as the rate of interest on a loan

External economies of scale

• Concentration economies of scale

• Infrastructure economies of scale

• Technology and skill economies of scale

Concentration economies of scale

• As an industry increases in size tye business within that industry may benefit from being close to one another

• E.g. new restaurant located near other restaurantssaves moeny on marketing

Infrastructure economies of scale

As the industry in a particular area increases there is leilly to be better transport and communication links which benefit all businesses in that area and reduce costs

Technology and skill economies of scale

• As an industry increases in size more people are likely to train to work in tgat industry and other businesses are liekly to develop better technology for that business

• Bothe factors likely to decrease avergae costs of a business

Diseconomies of scale

• Increases average costs that can occur from the growth of a business

• This is due to a business growing to large and gets to a point where benefits of growing are overtaken by the limitation

Reasons for diseconomies of scale

• Communication diseconomies of scale

• Coordination diseconomies of scale

• Motivation diseconomies of scale

Communication diseconomies of scale

• As a business increases output communication may become difficult

• E.g.a business that opens a second factory may have to spend money to make sure both factories get the same message

Coordination diseconomies of scale

As a business increases output organising a complicated production process may get more difficult and businesses costs may increase to overcome this

Motivation diseconomies of scale

• In a small business it is easy to make sure all of your employees are motivated and therefore produce to their best ability

• If a firm increases output not ever manager is likely to be able to motivate all employess

• This is likely to increase average costs of production

Minimuk efficient scale

Lowest point on the average cost curve

Evaluation of economics and diseconomies of scale

• Demand of the product or service- Economies and diseconomies of scale are based on increase in output- however the market may not demand this output if firm increases production then it needs to be able to seel all of this output

• The nature of production- e.g. a car manufacturer benefits from technical economies of scale however it is unlikely to be the case to the same degree fro a hairdresser

• Technological advancements- technological chnages have led to some smaller firms being able to access savings that were once only available to larger firms

• The importance of price- economies of scale allow a business to charge a lower price however if product is price inelastic there may not be the incentive for a firm to produce at the minimum efficient scale

• The nature of the product or service- Some products and services tend to benefit from economies of scale more than others e.g. kany taxi drivers operate their own because there are few economies of scale to be gained through growth

What is average fixed costs

• total fixed costs/ output

• It reduces as the business produces more because he cost is spread over more units