Scale

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Scale

  1. 1. http://www.bized.co.ukEconomies of Scale Copyright 2006 – Biz/ed
  2. 2. http://www.bized.co.uk 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 Copyright 2006 – Biz/ed
  3. 3. http://www.bized.co.uk Economies of Scale• Internal – advantages that arise as a result of the growth of the firm – Technical – Commercial – Financial – Managerial – Risk Bearing Copyright 2006 – Biz/ed
  4. 4. http://www.bized.co.uk 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• Reputation• Local knowledge and skills• Infrastructure• Training facilities Copyright 2006 – Biz/ed
  5. 5. http://www.bized.co.uk Economies of Scale Capital Land Labour Output TC ACScale A 5 3 4 100Scale B 10 6 8 300•Assume each unit of capital = £5, Land = £8and Labour = £2•Calculate TC and then AC for the two different‘scales’ (‘sizes’) of production facility•What happens and why? Copyright 2006 – Biz/ed
  6. 6. http://www.bized.co.uk Economies of Scale Capital Land Labour Output TC ACScale A 5 3 4 100 57 0.57Scale B 10 6 8 300 164 0.54•Doubling the scale of production (a rise of 100%) has ledto an increase in output of 200% - therefore cost ofproduction•PER UNIT has fallen•Don’t get confused between Total Cost and Average Cost•Overall ‘costs’ will rise but unit costs can fall•Why? Copyright 2006 – Biz/ed
  7. 7. http://www.bized.co.uk Economies of Scale• Internal: 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 Copyright 2006 – Biz/ed
  8. 8. http://www.bized.co.uk 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. Copyright 2006 – Biz/ed
  9. 9. http://www.bized.co.uk 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 Copyright 2006 – Biz/ed
  10. 10. http://www.bized.co.uk Economies of Scale• Principle of Multiples: e.g. Machine A Machine B Machine C Machine D Capacity = Capacity = Capacity = Capacity = 10 per hour 20 per hour 15 per hour 30 per hour Cost = £100 Cost = £50 Cost = £150 Cost = £200 per machine per machine per machine per machineCompany A = 1 of each machine, output per hour = 10Total Cost = £500AC = £50 per unitCompany B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60Total Cost = £1750AC = £29.16 per unit Copyright 2006 – Biz/ed
  11. 11. http://www.bized.co.uk Economies of ScaleIncreased Dimensions: e.g. Transport container = Volume of 20m3 Total Cost: Construction, driver, fuel, 2m maintenance, insurance, road tax = 2m £600 per journey 5m AC = £30m3 Total Cost = £1800 per journey AC = £11.25m34m 4m 10m Transport Container 2 = Volume 160m3 Copyright 2006 – Biz/ed
  12. 12. http://www.bized.co.uk 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 Copyright 2006 – Biz/ed
  13. 13. http://www.bized.co.uk Economies of Scale• 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 Copyright 2006 – Biz/ed
  14. 14. http://www.bized.co.uk Economies of Scale• Managerial –Use of specialists – accountants, marketing, lawyers, production, human resources, etc. Copyright 2006 – Biz/ed
  15. 15. http://www.bized.co.uk Economies of Scale• Risk Bearing –Diversification –Markets across regions/countries –Product ranges –R&D Copyright 2006 – Biz/ed
  16. 16. http://www.bized.co.uk Economies of ScaleMinimum Efficient Scale – the pointat which the increase in the scale of productionyields no significant unit cost benefitsMinimum Efficient Plant Size – thepoint where increasing the scale of production of anindividual plant within the industry yieldsno significant unit cost benefits Copyright 2006 – Biz/ed
  17. 17. http://www.bized.co.uk Economies of ScaleUnit Cost Scale A 82p Scale B 54p LRAC MES Output Copyright 2006 – Biz/ed
  18. 18. http://www.bized.co.uk 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 Copyright 2006 – Biz/ed

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