Economics
Economies of Scale
Economies of scale refer to the cost advantages that a business can achieve as it increases its level of production. This concept suggests that as the scale of production increases, the average cost per unit of output decreases. This is often due to factors such as spreading fixed costs over a larger output, increased specialization, and improved efficiency.
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11 Key excerpts on "Economies of Scale"
No longer available |Learn more- (Author)
- 2014(Publication Date)
- Orange Apple(Publisher)
____________________ WORLD TECHNOLOGIES ____________________ Chapter- 3 Economies of Scale As quantity of production increases from Q to Q2, the average cost of each unit decreases from C to C1. Economies of Scale , in microeconomics, refers to the cost advantages that a business obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. Economies of Scale is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase. DisEconomies of Scale are the opposite. The common sources of Economies of Scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial ____________________ WORLD TECHNOLOGIES ____________________ instruments), marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function). Each of these factors reduces the long run average costs (LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to the right. Economies of Scale are also derived partially from learning by doing. Economies of Scale is a practical concept that is important for explaining real world phenomena such as patterns of international trade, the number of firms in a market, and how firms get too big to fail. The exploitation of Economies of Scale helps explain why companies grow large in some industries. It is also a justification for free trade policies, since some Economies of Scale may require a larger market than is possible within a particular country — for example, it would not be efficient for Liechtenstein to have its own car maker, if they would only sell to their local market.
No longer available |Learn more- (Author)
- 2014(Publication Date)
- College Publishing House(Publisher)
____________________ WORLD TECHNOLOGIES ____________________ Chapter- 10 Economies of Scale As quantity of production increases from Q to Q2, the average cost of each unit decreases from C to C1. Economies of Scale , in microeconomics, refers to the cost advantages that a business obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. Economies of Scale is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase. DisEconomies of Scale are the opposite. The common sources of Economies of Scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), marketing (spreading the cost of advertising over a greater range of output ____________________ WORLD TECHNOLOGIES ____________________ in media markets), and technological (taking advantage of returns to scale in the production function). Each of these factors reduces the long run average costs (LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to the right. Economies of Scale are also derived partially from learning by doing. Economies of Scale is a practical concept that is important for explaining real world phenomena such as patterns of international trade, the number of firms in a market, and how firms get too big to fail. The exploitation of Economies of Scale helps explain why companies grow large in some industries. It is also a justification for free trade policies, since some Economies of Scale may require a larger market than is possible within a particular country — for example, it would not be efficient for Liechtenstein to have its own car maker, if they would only sell to their local market.
eBook - PDF- David Besanko, David Dranove, Mark Shanley, Scott Schaefer(Authors)
- 2014(Publication Date)
- Wiley(Publisher)
T HE H ORIZONTAL B OUNDARIES OF THE F IRM 2 F ew concepts in microeconomics, if any, are more fundamental to business strategy than the horizontal boundaries of the firm and the closely related topics of Economies of Scale and economies of scope. Economies of Scale allow some firms to achieve a cost advantage over their rivals and are a key determinant of market structure and entry. Even the internal organization of a firm can be affected by the importance of realizing scale economies. We mostly think about Economies of Scale as a key determinant of a firm’s horizontal boundaries, which identify the quantities and varieties of products and services that it produces. In some industries, such as microprocessors and airframe manufacturing, Economies of Scale are huge and a few large firms dominate. In other industries, such as web site design and shoe production, scale economies are mini-mal and small firms are the norm. Some industries, such as beer and computer software, have large market leaders (Anheuser-Busch, Microsoft), yet small firms (Boston Beer Company, Blizzard Entertainment) fill niches where scale economies are less important. An understanding of the sources of Economies of Scale and scope is clearly critical for formulating and assessing competitive strategy. This chapter identifies the key sources of Economies of Scale and scope and provides approaches for assessing their importance. D EFINITIONS Informally, when there are Economies of Scale and scope, “bigger is better.” To facili-tate identification and measurement, it is useful to define Economies of Scale and scope more precisely. Definition of Economies of Scale The production process for a specific good or service exhibits Economies of Scale over a range of output when average cost (i.e., cost per unit of output) declines over that range. If average cost ( AC ) declines as output increases, then the marginal cost of 61
eBook - PDFMicroeconomics
A Global Text
- Judy Whitehead(Author)
- 2020(Publication Date)
- Routledge(Publisher)
Producers who are limited either by the size of their market or by the availability of funds and can only reach, say, level Q 1 , will find that they remain uncompetitive on price with other larger producers who produce at or above the quantity Q * and are selling in the same market. As a corollary, it also suggests, however, that once a producer can attain the minimum optimum scale, producers operating at much larger scales would have little if any cost advantage. The signal to producers fearing competition in a newly opened market, for example, is to seek to identify the minimum optimal scale for their industry and attempt to reach this level of output in order to meet any competitive challenges. This assumes that the firms are all using the same technology (managerial, production, etc.) meaning that they are essentially using the same production function. 6.4 Economies of Scale The concept of Economies of Scale is a long-run phenomenon. These Economies of Scale are internal to the firm and may arise from increasing the number of plants (plant replication) as well as from increasing plant size. They may also derive from expanding the plant with the same product or by diversifying into other products. DisEconomies of Scale must be considered as well. Internal economies and disEconomies of Scale should be distinguished from external economies and diseconomies. Whereas internal economies determine the shape of the long-run average cost curve, external economies cause shifts in the position of the long-run average cost curve. External economies and diseconomies are exogenous factors generally outside of the producer’s control, such as the cost of inputs. Economies and disEconomies of Scale should also be distinguished from economies and diseconomies of scope although there are some interrelationships.
eBook - PDFIndustrial Organization
Contemporary Theory and Empirical Applications
- Lynne Pepall, Dan Richards, George Norman(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
As noted above, firms have to expect to break even in order for production to be profitable. This means that both average cost and sunk cost play a role in determining market structure. We consider average cost first. When average cost falls as output increases, it means that the cost per unit of output declines as the scale of operations rises. It is natural to describe this state of affairs as one in which there are Economies of Scale. If, however, unit costs rise as production increases, we say that there are disEconomies of Scale. Fundamentally, the presence of scale economies or scale diseconomies reflects the underlying technology. Some factors of production simply cannot be scaled down to small levels of production. For example, provision of passenger rail service between Omaha and Lincoln, Nebraska, will require approximately sixty miles of track whether the number of trains per day is one or twenty. As a result, a passenger train firm renting the track from the freight company that currently owns it will have to pay the same rent whether it has many passengers or just a few. Yet it is not just the presence of large fixed costs that gives rise to scale economies. For many productive processes, there are efficiencies that come about just as a result of being larger. To begin with, size permits a greater division of labor, as Adam Smith noted over 200 years ago. 5 This in turn permits specialization and more efficient production. Sometimes, the simple mathematics of the activity give rise to important scale effects. It is well known, for example, that the cost of a container will rise roughly in proportion to its surface area (essentially, the radius squared), whereas its capacity rises roughly in proportion to its volume (essentially, the radius cubed). Thus, while a 10x10x10 cube will hold 1,000 cubic feet, a 20x20x20 cube holds 8,000 cubic feet.
eBook - PDFSurfing the Global Tide
Automotive Giants and How to Survive Them
- M. Wynn-Williams(Author)
- 2009(Publication Date)
- Palgrave Macmillan(Publisher)
Each activity has its own optimum level and these need to be matched in order that the total production process should exploit the available econ- omies of scale. Beyond the production processes there are also economies of scope which bring additional advantages to a firm when adding new products to its range, thereby utilizing existing company facilities more efficiently. Although economies of scope are not derived from the produc- tion technology, and therefore do not determine the Economies of Scale in the industry or the ideal size of firms, by raising overall efficiency they can engender greater sustainability. 2.1 Economies of size Large firms enjoy a number of benefits over smaller rivals: Pratten (1971) pointed to the power that comes with market dominance. A firm might 20 21 Fundamentals of scale find it has some monopoly power in setting market prices or extracting lower prices from its suppliers. A larger firm might have political power, able to influence legislation and tax revenue policies in its favor. Internally, larger firms also benefit from team production where members of the team can specialize in tasks (Parkin et al. 1997). The two main advantages that accrue to a large company are connected with its production capability: Economies of Scale and economies of scope. Economies of Scale are related to technical efficiencies, and industries that experience its effects find that unit costs of production decrease as plant size is increased. It is important for planning purposes to note, however, that beyond a certain point an increased size of plant may be less effi- cient; progressively larger plants are then said to be experiencing disecon- omies of scale. This consideration of optimal size is a core theme of this book since Economies of Scale indicate the ideal plant size for a firm, and thereby the ideal size for the firm as a whole. Economies of scope exist when a large firm gains efficiency by more intensive use of its facilities.
- Dudley Jackson(Author)
- 2018(Publication Date)
- Routledge(Publisher)
7.2 The taxonomy of Economies of Scale The taxonomy of Economies of Scale and related concepts is quite complex. Figure 7.1 shows the scheme of classification proposed for this book. Very broadly, we are concerned with the relationship between volume of production per period and the cost of producing that volume of production, where this 171 172 Profitability, M echanization and Econom ies o f Scale Figure 7.1 Classification scheme for Economies of Scale and related concepts Econom ies o f Scale in Theory 173 volume-cost relationship is such as to increase the efficiency rate of profit as the volume of production increases between establishments each specifically designed and equipped for its volume of production per period. Generally we will be concerned with a production period of one year. There are four possible types of comparison involved in this volume-cost relationship and each leads to a different understanding of an increasing efficiency rate of profit as the volume of production increases. Each type of comparison needs to be understood although this book is concerned only with comparisons of the first type. It is important to understand that the comparison must always be in terms of a comparison between two or more distinct establishments or plants. To illustrate, except for the case of economies of scope (which will be briefly discussed) the comparison which we must always keep in mind is a comparison between Plant 1 and Plant 2, each producing the same type of product, Product H (and only that type of product), where Plant 1 is designed and equipped from the outset to produce quantity of output X per annum and Plant 2 is designed and equipped from the outset to produce quantity of output (X+ Y) per annum. Each of Plant 1 and Plant 2 must be on the production frontier (otherwise we will not be comparing like with like).
eBook - PDF- Basil Blackwell, Samuel Eilon(Authors)
- 2013(Publication Date)
- Butterworth-Heinemann(Publisher)
Up to the optimal point the long-run average unit cost declines and production is said to display Economies of Scale, while beyond that point disEconomies of Scale are manifest. Economies of Scale result from a combination of many factors, chief amongst them being: spread of fixed costs over a larger volume output, greater labour productivity achieved in a larger plant through a greater degree of specialization, use of more special-purpose equipment coupled with more efficient and more productive use of the equipment, better organization and control of production and inventories, use of quantity discounts in bulk purchasing of materials and services, and better utiliz-ation of space and transport facilities. As for the phenomenon of disEconomies of Scale, the usual argument is (Pappas and Brigham, 1979): At some output level Economies of Scale typically no longer hold, and average costs begin to rise. Increasing average costs at high output levels are often attributed to limitation in the ability of management to coordinate an organiz-ation after it reaches a very large size. This means both that staffs tend to grow more than proportionately with output, causing unit costs to rise, and that managements become less efficient as size increases, again raising the cost of producing a product... While the existence of such disEconomies of Scale is disputed by some researchers, the evidence indicates that diseconomies may be significant in certain industries. For a multiplant firm, where the total cost is the sum of the costs of the individual plants, it is then suggested (Pappas and Brigham, 1979) that the Big is necessary 75 Volume Volume Volume 1 Constant costs 2 Declining costs 3 U-shaped cost curve Figure 4.5 Three possible long-term unit cost curves Source: Pappas and Brigham, 1979 resultant long-run unit cost may take one of the forms shov^n in Figure 4.5: 1 The costs decline and then remain constant and unaffected by changes in volume.
eBook - PDFManagerial Economics
Problem-Solving in a Digital World
- Nick Wilkinson(Author)
- 2022(Publication Date)
- Cambridge University Press(Publisher)
Larger firms may have other disadvantages, in terms of having less flexibility, a slower speed of response to environmental changes and the reduced ability to offer personal service to their customers. 7.3.4 Economies of Scope Whereas Economies of Scale relate to cost reductions caused by increasing scale, economies of scope occur when changing the mix of operations has cost benefits. For example, producing 100,000 units of product X may involve a unit cost of £100 if X is produced by itself; but, if 100,000 units of X are produced along with a quantity of product Y, then the unit cost of producing X may fall. The same may happen to the unit cost of Y compared with producing it by itself. There are two main causes of this. 1. The products may use common processing facilities; an example would be different car models being produced at the same plant. 2. There may be cost complementarity, especially when there are joint products or by- products, such as with petrochemicals. 344 7 Cost Theory It is also possible for a firm to experience diseconomies of scope if it sells products that ‘clash’ with each other in some way. An example would be EMI Records in the late 1970s, when they signed the punk rock band the Sex Pistols, who openly advocated the use of violence. Since EMI were also marketing hospital equipment at the time, they faced consid- erable criticism and decided to drop their recording contract, at considerable cost. The extent of economies of scope can be measured by estimating the percentage cost reduction caused by joint production, as follows: S ¼ CðQ 1 Þ þ CðQ 2 Þ – CðQ 1 þ Q 2 Þ CðQ 1 þ Q 2 Þ (7.16) where C(Q 1 ) and C(Q 2 ) represent the costs of producing outputs Q 1 and Q 2 independently, and C(Q 1 + Q 2 ) represents the cost of producing outputs Q 1 and Q 2 jointly. If economies of scope exist, the joint cost is less than the sum of the individual costs, and so S is positive.
eBook - PDFStrategic Management
Concepts and Cases
- Jeffrey H. Dyer, Paul C. Godfrey, Robert J. Jensen, David J. Bryce(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
In large organizations, disEconomies of Scale can happen because large plants become very complex to manage. This increase in size and complexity tends to lead to increased waste and lower employee motiva- tion, which, in turn, leads to increased supervision costs. Moreover, while large firms typically have an advantage in economic upturns, they are sometimes at a disadvantage during downturns because they have more difficulty spreading fixed costs when demand declines, as described in Strategy in Practice: The Downside of Size and Scale in the Airline Industry. scale curve A graphic representation of the relationship between cost per unit and scale (volume) of production in a given time period. minimum efficient scale The smallest level of output (unit volume) that a plant or firm can produce to minimize its long- run average costs. In a graphic presentation of output/unit volume (x-axis) and cost per unit (y-axis), it is the output level where costs per unit flatten and no longer continue going down with increased output. disEconomies of Scale An increase in marginal cost when output is increased. Low Economies of Scale Minimum Efficient Scale (optimal quantity) DisEconomies of Scale High Volume of Production Cost per Unit of Production Q 1 FIGURE 4.1 Economies of Scale Strategy in Practice The Downside of Size and Scale in the Airline Industry After the terrorist attacks on September 11, 2001, airlines in the United States experienced a dramatic decrease in passengers because people were worried about flying. 11 During the prior 10-year period, American, Delta, and Northwest—the largest carri- ers in the United States—had been among the most profitable, in large part because of their Economies of Scale. But during the three- year period immediately following 9/11, these three airlines were among the least profitable. So how did being a large airline become a liability? There were many contributing factors.
- Arne Hallam(Author)
- 2019(Publication Date)
- CRC Press(Publisher)
The next section of the chapter addresses the definition of economies of size and the relationship between economies of size, scale, and scope. Particular attention is devoted to the multiproduct firm and issues relating to firm homogeneity in empirical work. Extensions to the basic static concepts are also discussed. A short section on the market implications of size economies is followed by a discussion of alternative ways to measure economies of size, scale, and scope using a variety of methods and data sources. The conclusion outlines areas of clear direction, areas of continued debate, and guidelines for future research. Economies of Size: Some Tentative Definitions Single Product Firms Under Certainty Before defining economies of size, it is useful to define the related concept of returns to scale. Assume the production function is given by (1) where y is output and x is the vector of inputs xt···n· Let f have the usual neoclassical properties of quasiconcavity, strict positive monotonicity, and twice continuous differentiability in x. Then the function is said to exhibit nonincreasing returns to scale if for all x £ R~ ~1, and O 0 153 f(fb) • 9f(x) This global definition of returns to scale is often supplemented by a local one that has a specific numerical magnitude. The elasticity of scale (Ferguson 1981) is implicitly defined by ain /(b) £ ·-p...,-atn X (2) This simply explains how output changes as inputs are changed in fixed proportions (along a ray through the origin). Intuitively, this measures how changes in inputs are scaled into output changes.
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