Economics Unit 3 -Economies of Scale

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Economics Unit 3 -Economies of Scale

  1. 1. AdduHigh schoolDepartment of business studiesPrepared byShijumonXavier<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  2. 2. Economies of Scale<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  3. 3. Economies of Scale<br />The advantages of large scale production that result in lower unit (average) costs (cost per unit)<br />AC = TC / Q<br />Economies of scale – spreads total costs over a greater range of output<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  4. 4. Economies of Scale<br />Internal – advantages that arise as a result of the growth of the firm<br />Technical<br />Commercial<br />Financial<br />Managerial<br />Risk Bearing<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  5. 5. Economies of Scale<br />External economies of scale – the advantages firms can gain as a result of the growth of the industry – normally associated with a particular area<br />Supply of skilled labour<br />Reputation<br />Local knowledge and skills<br />Infrastructure<br />Training facilities<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  6. 6. Economies of Scale<br /><ul><li>Assume each unit of capital = £5, Land = £8 and Labour = £2
  7. 7. Calculate TC and then AC for the two different ‘scales’ (‘sizes’) of production facility
  8. 8. What happens and why?</li></ul>6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  9. 9. Economies of Scale<br /><ul><li>Doubling the scale of production (a rise of 100%) has led to an increase in output of 200% - therefore cost of production
  10. 10. PER UNIT has fallen
  11. 11. Don’t get confused between Total Cost and Average Cost
  12. 12. Overall ‘costs’ will rise but unit costscan fall
  13. 13. Why?</li></ul>6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  14. 14. Economies of Scale<br />Internal: Technical<br />Specialisation – large organisations can employ specialised labour<br />Indivisibility of plant – machines can’t be broken down to do smaller jobs!<br />Principle of multiples – firms using more than one machine of different capacities - more efficient<br />Increased dimensions – bigger containers can reduce average cost<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  15. 15. Economies of Scale<br />Indivisibility of Plant:<br />Not viable to produce products like oil, chemicals on small scale – need large amounts of capital<br />Agriculture – machinery appropriate for large scale work – combines, etc.<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  16. 16. Economies of Scale<br />Principle of Multiples:<br />Some production processes need more than one machine<br />Different capacities<br />May need more than one machine to be fully efficient<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  17. 17. Economies of Scale<br />Principle of Multiples: e.g.<br />Company A = 1 of each machine, output per hour = 10<br />Total Cost = £500<br />AC = £50 per unit <br />Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60<br />Total Cost = £1750<br />AC = £29.16 per unit<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  18. 18. Economies of Scale<br />Increased Dimensions: e.g.<br />Transport container = Volume of 20m3<br />Total Cost: Construction, driver, fuel, <br />maintenance, insurance, road tax = <br />£600 per journey<br />AC = £30m3<br />2m<br />2m<br />5m<br />Total Cost = £1800 per journey<br />AC = £11.25m3<br />4m<br />4m<br />10m<br />Transport Container 2 = Volume 160m3<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  19. 19. Economies of Scale<br />Commercial<br />Large firms can negotiate favourable prices as a result of buying in bulk<br />Large firms may have advantages in keeping prices higher because of their market power<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  20. 20. Economies of Scale<br />Financial<br />Large firms able to negotiate cheaper finance deals<br />Large firms able to be more flexible about finance – share options, rights issues, etc. <br />Large firms able to utilise skills of merchant banks to arrange finance<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  21. 21. Economies of Scale<br />Managerial<br />Use of specialists – accountants, marketing, lawyers, production, human resources, etc.<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  22. 22. Economies of Scale<br />Risk Bearing<br />Diversification<br />Markets across regions/countries<br />Product ranges<br />R&D<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  23. 23. Economies of Scale<br />Minimum Efficient Scale<br />– the point at which the increase in the scale of production yields no significant unit cost benefits<br />Minimum Efficient Plant Size<br /> – the point where increasing the scale of production of an individual plant within the industry yields no significant unit cost benefits.<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  24. 24. Economies of Scale<br />Unit Cost<br />Scale A<br />Scale B<br />82p<br />54p<br />LRAC<br />MES<br />Output<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />
  25. 25. Diseconomies of Scale<br />The disadvantages of large scale production that can lead to increasing average costs<br />Problems of management<br />Maintaining effective communication<br />Co-ordinating activities – often across the globe!<br />De-motivation and alienation of staff<br />Divorce of ownership and control<br />6/20/2011<br />Addu High School, S.Hithadhoo . Dept. of Business Studies A’ level. 2011/ Grade12 Economics <br />

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