1. Economies of Scale Asst. Prof. Dr. Serdar AYAN

2. Economies of Scale The advantages of large scale production that result in lower unit (average) costs (cost per unit) AC = TC / Q Economies of Scale – spreads total costs over a greater range of output.

3. Economies of Scale Capital LandLabourOutput TCAC Scale A 534100 82 Scale B 1068300 164 Assume each unit of capital = 5 TL, Land = 8 TL and Labour = 2 TL Calculate AC for the two different ‘scales’ (sizes’) of production facility What happens and why?

4. Economies of Scale Capital LandLabourOutput TCAC Scale A 534100820.82 Scale B 10683001640.54 Doubling the scale of production (a rise of 100%) has led to an increase in output of 200% - therefore cost of production PER UNIT has fallen Don’t get confused between Total Cost and Average Cost, Overall ‘costs’ will rise but unit costs can fall. Why?

5. Economies of Scale Internal Economies of Scale advantages that arise as a result of the growth of the firm –Technical –Commercial –Financial –Managerial –Risk Bearing

6. http://www.bized.ac.uk Copyright 2003 – Biz/ed Economies of Scale Technical –Specialisation – large organisations can employ specialised labour –Indivisibility of plant – machines can’t be broken down to do smaller jobs! –Principle of multiples – firms using more than one machine of different capacities more efficient –Increased dimensions – bigger containers can reduce average cost

7. Economies of Scale Indivisibility of Plant: Not viable to produce products like oil, chemicals on small scale – need large amounts of capital Agriculture – machinery appropriate for large scale work – combines etc,

8. Economies of Scale Principle of Multiples: Some production processes need more than one machine Different capacities May need more than one machine to be fully efficient

9. Economies of Scale Principle of Multiples: EG Machine AMachine BMachine CMachine D Capacity = 10 per hour Capacity = 20 per hour Capacity = 15 per hour Capacity = 30 per hour Cost = 100 TL per machine Cost = 50 TL per machine Cost = 150 TL per machine Cost = 200 TL per machine

10. Economies of Scale Principle of Multiples: EG Machine AMachine BMachine CMachine D Capacity = 10 per hour Capacity = 20 per hour Capacity = 15 per hour Capacity = 30 per hour Cost = 100 TL per machine Cost = 50 TL per machine Cost = 150 TL per machine Cost = 200 TL per machine Company A = 1 of each machine, output per hour = 10 Total Cost = 500 TL AC = 50 TL per unit

11. Economies of Scale Principle of Multiples: EG Machine AMachine BMachine CMachine D Capacity = 10 per hour Capacity = 20 per hour Capacity = 15 per hour Capacity = 30 per hour Cost = 100 TL per machine Cost = 50 TL per machine Cost = 150 TL per machine Cost = 200 TL per machine Company A = 1 of each machine, output per hour = 10 Total Cost = 500 TL AC = 50 TL per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60 Total Cost = 1750 TL AC = 29.16 TL per unit

12. Economies of Scale Increased Dimensions 5m 2m Transport container 1 = Volume of 20m 3 Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 600TL per journey AC = 30m 3 TL 4m 10m 4m Transport Container 2 = Volume 160m 3 Total Cost = 1800TL per journey AC = 11.25m 3 TL

13. Economies of Scale Commercial Large firms can negotiate favourable prices as a result of buying in bulk Large firms may have advantages in keeping prices higher because of their market power

14. Economies of Scale Financial Large firms able to negotiate cheaper finance deals Large firms able to be more flexible about finance Large firms able to utilise skills of merchant banks to arrange finance

15. Economies of Scale Managerial –Use of specialists – accountants, marketing, lawyers, production, human resources etc

16. Economies of Scale Risk Bearing –Diversification –Markets across regions/countries –Product ranges –R&D

17. http://www.bized.ac.uk Copyright 2003 – Biz/ed Economies of Scale External Economies of Scale – the advantages firms can gain as a result of the growth of the industry – normally associated with a particular area Supply of skilled labour Local knowledge and Skills Infrastructure Training facilities

18. Diseconomies of Scale The disadvantages of large scale production that can lead to increasing average costs –Problems of management –Maintaining effective communication –Co-ordinating activities – often across the globe! –De-motivation and alienation of staff –Divorce of ownership and control