2. Economies of Scale and
International Trade: An Overview
Ricardian model- Uses the assumptions
of constant returns to scale and perfect
competition:
Increasing the amount of all inputs used
in the production of any commodity will
increase output of that commodity in the
same proportion.
The larger the scale of production ,
greater is it’s efficiency.
3. 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
4. Advantages:
Internal – advantages that arise as a
result of the growth of the firm
Technical
Commercial
Financial
Managerial
Risk Bearing
5. External economies of scale – the
advantages firms can gain as a result
of the growth of the industry
Supply of skilled labour
Reputation
Local knowledge and skills
Infrastructure
Training facilities
6. Capital Labour Land Output Total
cost
Avg.
cost
Scale A 5 4 3 100
Scale B 10 8 6 300
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?
7. Capital Labour Land Output Total
cost
Avg.
cost
Scale A 5 4 3 100 57 0.57
Scale B 10 8 6 300 164 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
8. Assumptions of the Model
(characteristics of Monopolistic
competition)
Imagine an industry consisting of a number of
firms producing differentiated products.
Two key assumptions
Each firm is assumed to be able to differentiate
its product from its rivals.
Each firm is assumed to take the prices
charged by its rivals as given.
We expect a firm:
To sell more the larger the total demand for its
industry’s product and the higher the prices
charged by its rivals
To sell less the greater the number of firms in
the industry and the higher its own price
9. Imperfect Competition
Firms are aware that they can influence
the price of their product. (Price Setter)
They know that they can sell more only by
reducing their price.
The simplest imperfectly competitive
market structure is that of a pure
monopoly, a market in which a firm faces
no competition
10. Marginal Revenue
The extra revenue the firm gains from
selling an additional unit
Its curve, MR, always lies below the
demand curve, D.
11. The Theory of
Imperfect Competition
Monopolistic Pricing and Production Decisions
D
Cost, C and
Price, P
Quantity, Q
Monopoly profits
AC
PM
Q
M
MR
MC
AC
12. Average Versus Marginal Cost
Average cost
Marginal cost
1
2
0
3
4
5
6
2 4 6 8 10 12 14 16 18 20 22 24
Cost per unit
Output
13. 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
15. 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
16. Conclusion
According to the research , we can
conclude that when economies of
scale helps in production efficiency
and lowers per unit cost, some
diseconomies of scale should also be
counted, and the business processes
should be constantly reviewed at
certain milestones.
