Economies and Diseconomies of scale

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A2 revision presentation on aspects of economies of scale, diseconomies of scale, economies of scope, minimum efficient scale

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Economies and Diseconomies of scale

  1. 1. Economies and Diseconomies of Scale - Analysis A2 Micro – Autumn 2013
  2. 2. Get help from fellow students, teachers and tutor2u on Twitter: #econ3 @tutor2u_econ
  3. 3. Buying economies Buying in greater quantities usually results in a lower price (bulk- buying) – the use of monopsony power Technical Use of specialist equipment / bulky units of capital or specialist processes to boost productivity e.g. law of increased dimensions Risk-bearing Grow a wider range of products and customer markets through diversification to lower market risk for investors Marketing Spreading a fixed marketing spend over a larger range of products, markets and customers Network Adding extra customers or users to a network that is already established (e.g. mobile phones) Financial Larger firms benefit from access to cheaper finance, smaller businesses often credit constrained Industry An external economy – all competitors benefit – e.g. specialist businesses grouped close together Internal Economies of Scale
  4. 4. Servers at Google
  5. 5. Retail Scale at Sainsbury’s
  6. 6. Long Run Cost Per Unit Output Cost per unit SRAC1 SRAC2 SRAC3 SRAC4 Internal economies of scale – falling unit costs as the scale of production grows
  7. 7. Long Run Cost Per Unit Output Cost per unit SRAC1 SRAC2 Economies of scale (increasing returns) Internal economies of scale – falling unit costs as the scale of production grows
  8. 8. Long Run Cost Per Unit Output Cost per unit SRAC1 SRAC2 Economies of scale (increasing returns) SRAC3 Constant returns to scale Internal economies of scale – falling unit costs as the scale of production grows
  9. 9. Long Run Cost Per Unit Output Cost per unit SRAC1 SRAC2 Economies of scale (increasing returns) SRAC3 SRAC4 Constant returns to scale Internal economies of scale – falling unit costs as the scale of production grows
  10. 10. Long Run Cost Per Unit Output Cost per unit SRAC1 SRAC2 Economies of scale (increasing returns) SRAC3 SRAC4 Constant returns to scale Diseconomies of scale LRAC Internal economies of scale – falling unit costs as the scale of production grows
  11. 11. Minimum Efficient Scale (MES) Output Cost per unit LRAC Economies of scale (increasing returns) Constant returns to scale Diseconomies of scale The minimum efficient scale is the scale of output where internal economies of scale have been fully exploited
  12. 12. Cost & Price Output (Q) Different Shapes of Long Run Average Cost Curves Low MES, limited scale economies, contestable market LRAC Q1 Minimum efficient scale (MES) Scope for many firms to reach the MES
  13. 13. Cost & Price Output (Q) Different Shapes of Long Run Average Cost Curves Low MES, limited scale economies, contestable market LRAC Q1 Output (Q) High MES, falling LRAC, barriers to contestability Extensive internal economies of scale leading to lower LRAC LRAC Natural Monopoly Minimum efficient scale (MES) Scope for many firms to reach the MES Q1 Q2 Q3 Q4
  14. 14. Falling LRAC for a natural monopoly Output (Q) High MES, falling LRAC, barriers to contestability Extensive internal economies of scale leading to lower LRAC LRAC Natural Monopoly Q1 Q2 Q3 Q4 London Underground Water & Sewerage Networks
  15. 15. Falling LRAC for a natural monopoly Output (Q) High MES, falling LRAC, barriers to contestability Extensive internal economies of scale leading to lower LRAC LRAC Natural Monopoly Q1 Q2 Q3 Q4 London Underground Water & Sewerage Networks
  16. 16. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 In this example, increasing the scale of production allows a move from AC1 to AC2
  17. 17. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR Add in the revenue curve (AR)
  18. 18. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR MR And the marginal revenue (MR)
  19. 19. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR MR Q1 P1 Profit maximising output is at Q1 and the optimum price is P1
  20. 20. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR MR Q1 P1 Q2 P2 With economies of scale, the profit maximising price and output changes to P2, Q2
  21. 21. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR MR Q1 P1 Q2 P2 Profit at price P1
  22. 22. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR MR Q1 P1 Q2 P2 Profit at price P1 Profit at price P2
  23. 23. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR MR Q1 P1 Q2 P2 What are the effects of this for consumer welfare?
  24. 24. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC1 AC2 MC1 MC2 AR MR Q1 P1 Q2 P2 Consumer surplus increases because of the higher output and lower price
  25. 25. Output (Q) Cost & Price Economies of Scale – Prices, Profit and Welfare AC2MC2 AR MR Q2 P2 Consumer surplus at P2
  26. 26. Falling LRAC for a natural monopoly Output (Q) Natural Monopoly Cost & Price LRAC
  27. 27. Falling LRAC for a natural monopoly Output (Q) LRMC Natural Monopoly Cost & Price LRAC With a natural monopoly, the long run average cost curve continues to fall over a huge range of output
  28. 28. Falling LRAC for a natural monopoly Output (Q) LRMC Natural Monopoly Cost & Price LRAC AR MR With a natural monopoly, the long run average cost curve continues to fall over a huge range of output
  29. 29. Falling LRAC for a natural monopoly Output (Q) LRMC Profit maximising output is lower than the minimum efficient scale Cost & Price LRAC AR MR Q1 P1
  30. 30. Falling LRAC for a natural monopoly Output (Q) LRMC Profit maximising output is lower than the minimum efficient scale Cost & Price LRAC AR MR Q1 P1 C1
  31. 31. Falling LRAC for a natural monopoly Output (Q) LRMC Total profit at Q1 Cost & Price LRAC AR MR Q1 P1 C1
  32. 32. Cost & Price Output (Q) Long Run Cost Advantages for Existing / Established Businesses Cost advantage for Firm A over a potential rival Firm B At output Q1 – firm A has a big cost advantage over a potential rival firm B Reasons? Firm B Firm A Q1 AC (B) AC (A)
  33. 33. Cost & Price Output (Q) Long Run Cost Advantages for Existing / Established Businesses Cost advantage for Firm A over a potential rival Firm B At output Q1 – firm A has a big cost advantage over a potential rival firm B 1. Learning economies 2. Vertical integration 3. Lower customer churn 4. Monopsony power Firm B Firm A Q1 AC (B) AC (A)
  34. 34. Learning Economies Output Cost (per unit of output) LRAC1 B Economies of Scale A LRAC2 Learning economies C
  35. 35. External Economies of Scale (EEoS) External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry Science Parks – University Research Agglomeration Economies – knowledge clusters
  36. 36. External Economies of Scale (EEoS) External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry Science Parks – University Research Agglomeration Economies – knowledge clusters
  37. 37. Granta Park in Cambridge
  38. 38. Agglomeration Clusters in Northamptonshire
  39. 39. Silicon Valley – Oakland, CA
  40. 40. Silicon Roundabout – Tech City
  41. 41. External Economies of Scale (EEoS) External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry Output LRAC1 B Internal Economies of Scale A Cost (per unit of output)
  42. 42. External Economies of Scale (EEoS) External economies of scale occur outside of a firm but within an industry – they arise from the growth of an industry Output LRAC1 B Internal Economies of Scale A Cost (per unit of output) LRAC2 (EEoS) External Economies of Scale
  43. 43. Economies of Scope Where it is cheaper to produce a range of products rather than specialize in a very limited number
  44. 44. Economies of Scope Where it is cheaper to produce a range of products rather than specialize in a very limited number Hypermarkets Amazon Proctor & Gamble
  45. 45. Economies of Scope Where it is cheaper to produce a range of products rather than specialize in a very limited number Hypermarkets Amazon Proctor & Gamble
  46. 46. Economies of Scope Where it is cheaper to produce a range of products rather than specialize in a very limited number Hypermarkets Amazon Proctor & Gamble
  47. 47. Amazon and Economies of Scope Amazon launched its groceries range, which includes tea, pasta and biscuits, in July 2010 with little more than 22,000 products. However, it now offers in excess of 150,000 products, from crisps to nappies, which are typically sold in bulk, as it attempts to gobble up sales from the high street
  48. 48. Poor communication within businesses More difficult to control a larger, more complex business More frequent machinery & employee breakdown if output & capacity utilisation is too high Loss of management focus, greater risk of industrial relations problems and possible strikes Factors which cause the average production cost per unit of a business to increase above the efficient level…for example Internal Diseconomies of Scale – Rising LRAC
  49. 49. Get help from fellow students, teachers and tutor2u on Twitter: #econ3 @tutor2u_econ

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