11. Economies of Scale Increased Dimensions: e.g. 5m 2m 2m Transport container = Volume of 20m 3 Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = £600 per journey AC = £30m 3 4m 10m 4m Transport Container 2 = Volume 160m 3 Total Cost = £1800 per journey AC = £11.25m 3
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16. 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
The aim here is to show a simple example of how a production process involving a combination of machines operating at different capacities can have an effect on unit costs. The example could be a bottling plant with each machine doing a different task – filling the bottles, labelling, putting the tops on and packaging. Company A being small can only afford 1 of each machine, it is constrained by the capacity of the slowest machine – machine A, the rest of the machines are not being used to their full capacity and so are wasted for some of the time. They still however represent a cost to the firm but there is no return coming in. The larger company can afford to buy multiples of each machine to ensure that they are all working to full capacity, the point to stress is that the total cost rises – obviously because there are more machines – by 2.5 times compared to company A but the output rises by 5 times the output level of company A hence AC falls. The point can be made that company A is at a significant cost disadvantage and hence this could affect its pricing structure and put it at a distinct competitive disadvantage.
The explanation that accompanies this slide is fairly straight forward – The first container has a carrying capacity of 20 cubic metres. The cost of carrying the product involves the actual construction of the container/lorry etc, the cost of the maintenance, driver etc. This is assumed to be £600 per journey and as such gives an average cost of £30 per cubic metre. Doubling the dimensions of the container increases the carrying capacity by 8 times. However, the cost of the construction, maintenance etc is not likely to rise by 8 times. The example shows cost having risen 2 times. As a result the cost per unit is now £11.25 per cubic metre! Again the point about the relative competitive advantage is worth highlighting.
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