economies and diseconomies of scale and returns to scale

economies of scale

• falling LRAC as output increases

• costs still rise however output is rising at a faster rate

diseconomies of scale

• rising LRAC as output increases

internal economies and diseconomies of scale

• changes in LRAC of production from changes in the size or scale of a firm or plant

external economies and diseconomies of scale

• changes LRAC of production resulting form the growth of the market or industry

• TCs are reduced as output increases leading to falling LRAC

examples of internal diseconomies of scale (3)

• managerial

  • administration of firms becomes more difficult as it grows

  • may lead to increase in cost of production if tasks delegated to workers who are not trained

  • workers more likely to ‘slack off‘ due to managers not being able to pay as much attention to each individual worker

• motivational

  • overspecialisation may lead to de-skilling

  • workers may feel less valued as they are easily replaceable therefore there is less of an incentive to use personal initiative

• communication failure

  • takes time and effort for messages to spread from the top of the organisation to the bottom - changes in operation

  • or takes time for messages from the bottom to be reached at the top - suggestions from floor workers are complaints regarding work conditions

  • impacts on productivity

examples of internal economies of scale (6)

• risk-bearing

  • some investment is very risky so only large firms will take the risk

  • spread risk over larger range of output

• financial

  • able to borrow larger amounts from banks and other financial lenders and likely at better rates than small firms

  • banks believe they are lower risk so more willing to do so

• managerial

  • benefit from effective division of labour within management and regular work force

  • employ specialist managers as a firm gets larger

  • they can monitor the productivity of the workforce and boost it

• technical

  • bringing in specialist machinery which can boost productivity

  • employing workers which are able to specialise as firm gets larger increases productivity

  • generated through changes to the productive process through investment in R&D creating dynamic efficiency

  • creates capital indivisibilities creating high barriers to entry

• marketing

  • bulk buy advertising

  • negotiate unit rates of advertising

  • spread advertising costs over larger range of products

• purchasing

  • able to buy raw material in bulk

  • able to negotiate unit discounts

  • spread costs over a wider range of output

minimum efficient scale

• the lowest level of output required to fully exploit economies of scale

• this means that after this quantity costs cannot get any lower

explain why external economies of scale occur (3)

• improved transport infrastructure

  • reduces costs when transporting goods and cheaper to access raw materials

• supportive legislation

  • if a firm grows and becomes vital to regional area it may gain some political power and even gain favours in the form of subsidies

• cluster effect

  • similar businesses located in the same area creates pool of skilled labour

  • easy access to supply of labour which reduces recruitment costs

explain what increasing returns to scale is

• when output increases at a faster rate than the increase in the scales for all factors of production employed

• this means ACs are decreasing

• due to experiencing economies of scale

constant returns to scale

• when the scale of all factors of production employed increases at the same rate as output

• this means that ACs are constant

explain what decreasing returns to scale is

• when the scale of all factors of production employed increases, the output increases at a slower rate

• this means ACs are increasing

• due to experiencing diseconomies of scale

returns to scale

• in the long run, the rate by which output changes if the scale of factors of production employed is changed

describe the difference between the long run and short run

• in the short run at least one factor of production is fixed and can’t be varied

  • this means that the only way a firm can produce more in the short run is by adding more variable factors of production to the fixed factor

  • usually assume that capital and land are fixed in the short run and labour is variable

• in the long run all factors of production can be varied thus the scale of all factors of production can be changed

explain law of diminishing returns

• short run law

• states that as variable factors of production is added to a fixed factor of production, marginal/ total product will initially rise then fall

• in economic short run, the factors of production are being underutilised so increasing labour increases productivity as specialisation and division of labour is able to take place

• labour productivity then decreases as fixed factors of production becomes a constrain on production so workers get in the way of one another due to limited work space

draw and annotate the diagram to show the law of diminishing returns

• law begins to set in at point A as although total product is increasing it is no doing so at a diminishing rate

• after point Y TP begins to fall as MP is now 0 which can be seen at point W

• this means that beyond this point any addition workers will contribute negatively to MP thus diminishing marginal returns