Economies Of Scale.ppt

Economies of Scale

Economies of Scale 

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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

Economies of Scale 

Internal – advantages that arise as a result of the growth of the firm     

Technical Commercial Financial Managerial Risk Bearing

Economies of Scale 

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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 Reputation Local knowledge and skills Infrastructure Training facilities

Economies of Scale Capital

Land

Labour

Output

Scale A

5

3

4

100

Scale B

10

6

8

300

TC

AC

•Assume each unit of capital = £5, Land = £8 and Labour = £2 •Calculate TC and then AC for the two different ‘scales’ (‘sizes’) of production facility •What happens and why?

Economies of Scale Capital

Land

Labour

Output

TC

AC

Scale A

5

3

4

100

57

0.57

Scale B

10

6

8

300

164

0.54

•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?

Economies of Scale 

Internal: Technical 

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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

Economies of Scale  

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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.

Economies of Scale  

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

Economies of Scale 

Principle of Multiples: e.g. Machine A Machine B

Machine C

Machine D

Capacity = 10 per hour

Capacity = 20 per hour

Capacity = 15 per hour

Capacity = 30 per hour

Cost = £100 per machine

Cost = £50 per machine

Cost = £150 per machine

Cost = £200 per machine

Company A = 1 of each machine, output per hour = 10 Total Cost = £500 AC = £50 per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60 Total Cost = £1750 AC = £29.16 per unit

Economies of Scale Increased Dimensions: e.g. Transport container = Volume of 20m3 Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 2m £600 per journey AC = £30m3

2m 5m

Total Cost = £1800 per journey AC = £11.25m3 4m 4m 10m

Transport Container 2 = Volume 160m3

Economies of Scale  

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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

Economies of Scale  

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Financial Large firms able to negotiate cheaper finance deals Large firms able to be more flexible about finance – share options, rights issues, etc. Large firms able to utilise skills of merchant banks to arrange finance

Economies of Scale 

Managerial 

Use of specialists – accountants, marketing, lawyers, production, human resources, etc.

Economies of Scale 

Risk Bearing Diversification  Markets across regions/countries  Product ranges  R&D 

Economies of Scale Minimum Efficient Scale – the point at which the increase in the scale of production yields no significant unit cost benefits

Minimum Efficient Plant Size – the

point where increasing the scale of production of an individual plant within the industry yields no significant unit cost benefits

Economies of Scale Unit Cost Scale A 82p Scale B 54p LRAC

MES

Output

Diseconomies of Scale 

The disadvantages of large scale production that can lead to increasing average costs   

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Problems of management Maintaining effective communication Co-ordinating activities – often across the globe! De-motivation and alienation of staff Divorce of ownership and control