Economies and diseconomies of scale 3.14 Operational Strategies: location Economies and diseconomies of scale

Candidates should be able to: Syllabus Candidates should be able to: Define types of economies of scale and diseconomies of scale Analyse the minimum efficient scale Distinguish between internal and external economies of scale

Economies of scale and long run average cost In the long run, all factors of production are _________ What will happen to costs? Initially long run costs _____ as output increases due to _____________ of scale e.g. a firm increases its output from 10 million units to 40 million units and TC increases from £10m to £20m; what has happened to ATC? Eventually firms become too large and their average costs start to rise: ___________________ of scale

Constant returns to scale and long run average cost It may be that long run average costs do not switch instantly from becoming cheaper to becoming more expensive: Initially long run costs fall as output increases due to ______________ of scale At some point long run average costs (LRAC) become constant Eventually firms become too large and their average costs start to rise: _______________ of scale

Short run cost schedules – diminishing returns TFC is a horizontal straight line showing that TFC is ___________ whatever the output. TC and TVC are parallel because the vertical distance between them is ________ The law of ____________ returns assumes that firms operate in the ________ run when at least one factor of production is _________ The inflections in the TC and TVC are caused by the change from increasing returns to diminishing returns. Do not confuse DIMINSHING RETURNS (_______ run) and ECONOMIES OF SCALE (___________ run)!!!

The long run and return to scale The law of diminishing returns assumes that firms operate in the short run. In the long run, a firm can ______ all their factor inputs If a % increase in inputs leads to: a larger % increase in output, this is known as increasing returns to scale the same % increase in output, this is called _____________ returns to scale a lower % increase in output, this is called ________________ returns to scale

Economies of scale and LRAC - explanation of diagram The LRAC curve is U shaped because LRAC: At first _________ due to economies of scale Then they are __________ Finally they ________ due to diseconomies of scale constant, fall, rise

The optimum level of production Productive efficiency occurs when production takes place at the ____________ cost. If the LRAC curve is U shaped, then productive efficiency occurs at the __________ of the curve when costs are constant (______________ returns to scale) Where is the optimal level of production?

The optimum level of production MES The output level at which lowest cost production starts is the minimum efficient scale (MES) of production (the point _____) If a firm is producing to the left of the MES, then LRAC will be ______________ If a firm is producing to the right of the MES then LRAC will either be the _______ (if there are constant returns) or _____________ (if there are diseconomies of scale)

Four types of internal economies of scale Technical economies Specialisation or managerial economies Purchasing and marketing economies Financial economies

Internal economies of scale - diseconomies What are diseconomies of scale? How might firms try to overcome this?

External economies of scale External economies of scale occur when there is an increase in the __________ in which the firm operates Why might this lead to lower training costs? Which might transport improve? What will happen to the LRAC curve?

Movements along the LRAC curve versus a shift What causes a movement along the LRAC curve? What might shift the LRAC curve downwards? What might shift the LRAC up?

External economies of scale External economies of scale occur when there is ______ in the size of the industry in which a business operates. For example: Growth of an industry which may lead to a new local ________ network which reduces costs for local firms Lower training costs because other firms in the area are training workers who it can ___________ The local authority may offer _______ training facilities The _______________ may help with export contracts New technology in the industry will _____________ average costs .

External economies, diseconomies of scale and the LRAC curve External economies of scale will shift the LRAC curve of an individual firm ______________ At any given output, average costs will be lower because the industry as a whole has grown. External diseconomies of scale will shift the LRAC curve __________________ This may arise if the industry grows quickly. When this happens, individual firms are then forced to compete with each other. Wages and raw materials will then ___________

Recap of short run average cost curve and LRAC curve In the short run at least one factor is ___________ SRAC fall at first and then begin to rise because of ______________________________________ In the long run all costs are __________________ LRAC change because of ___________________ ________________________________________ In the long run, a company will choose a scale of production that will maximise its ______________

Definitions _________________________________: a fall in the long run average costs of production as output rises _________________________________: a rise in the long run average costs of production as output rises _______________________________: falling average costs of production, shown by a downward shift in the average cost curve, which result from a growth in the size of the industry within which a firm operates ________________________________: economies of scale which arise because of the growth in the scale of production within a firm

Definitions continued ______________________________: the lowest level of output at which long run average cost is minimised ___________________________________: the range of output over which long run average cost is lowest