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Economy Of Scale


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managerial economics

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Economy Of Scale

  1. 1. Economics of scale Presented by:- Mahesh Gupta
  2. 2. Highlights <ul><li>What is Economics </li></ul><ul><li>What is Scale </li></ul><ul><li>Economics of Scale? </li></ul><ul><li>Types of Economies of Scale </li></ul><ul><li>Limitations </li></ul><ul><li>Internal & External Diseconomy </li></ul>
  3. 3. What is Economics? <ul><li>Economics is the study of how people choose to use resources. </li></ul><ul><li>Resources include the : </li></ul><ul><li>1.Time and talent people have available, </li></ul><ul><li>2.The land, buildings, equipment, and other tools on hand, and </li></ul><ul><li>3.The knowledge of how to combine them to create useful products and services. </li></ul>
  4. 4. What is Scale? <ul><li>An ordered reference standard; &quot;judging on a scale of 1 to 10&quot; </li></ul><ul><li>Pattern, make, regulate, set, measure, or estimate according to some rate or standard </li></ul><ul><li>The proportion between two sets of dimensions. </li></ul>
  5. 5. Economics of Scale <ul><li>Economics of Scale exist when the production cost of a single product decreases with the number of unit produced </li></ul><ul><li>Refer to the situation in which the cost of producing an additional unit of output (i.e., the marginal cost ) of a product (i.e., a good or service) decreases as the volume of output (i.e., the scale of production) increases </li></ul>
  6. 6. Economics of Scale <ul><li>It could also be defined as the situation in which an equal percentage increase in all inputs results in a greater percentage increase in output. </li></ul><ul><li>Generally, economies of scale is about the benefits gained by the production of large volume of a product </li></ul>
  7. 7. <ul><li>In business, economies of scale are usually considered in relation to specific areas of the production process, which may be technical, managerial, marketing, finance, and risk. </li></ul><ul><li>In achieving economies of scale, many factors must be considered. </li></ul><ul><li>The ability of larger entities (governments, businesses) to produce things more cheaply per unit because they produce so many </li></ul>
  8. 8. Type of Economy of Scale <ul><li>External economies - the cost per unit depends on the size of the industry, not the size of firm </li></ul><ul><li>Internal economies - the cost per unit depends on size of the individual firm . </li></ul>
  9. 9. Internal <ul><li>Internal economics of scale– advantages that arise as a result of the growth of the firm </li></ul><ul><ul><li>Technical </li></ul></ul><ul><ul><li>Commercial </li></ul></ul><ul><ul><li>Financial </li></ul></ul><ul><ul><li>Managerial </li></ul></ul><ul><ul><li>Risk Bearing </li></ul></ul>
  10. 10. Internal: Technical <ul><ul><li>Specialisation – large organisations can employ specialised labour </li></ul></ul><ul><ul><li>Indivisibility of plant – machines can’t be broken down to do smaller jobs! </li></ul></ul><ul><ul><li>Principle of multiples – firms using more than one machine of different capacities - more efficient </li></ul></ul><ul><ul><li>Increased dimensions – bigger containers can reduce average cost </li></ul></ul>
  11. 11. Commercial <ul><li>Large firms can negotiate favourable prices as a result of buying in bulk </li></ul><ul><li>Large firms may have advantages in keeping prices higher because of their market power </li></ul>
  12. 12. Financial <ul><li>Large firms able to negotiate cheaper finance deals </li></ul><ul><li>Large firms able to be more flexible about finance – share options, rights issues, etc. </li></ul><ul><li>Large firms able to utilise skills of merchant banks to arrange finance </li></ul>
  13. 13. Managerial <ul><ul><li>Use of specialists – accountants, marketing, lawyers, production, human resources, etc. </li></ul></ul>
  14. 14. Risk Bearing <ul><ul><li>Diversification </li></ul></ul><ul><ul><li>Markets across regions/countries </li></ul></ul><ul><ul><li>Product ranges </li></ul></ul><ul><ul><li>R&D </li></ul></ul>
  15. 15. External <ul><li>External economies of scale – the advantages firms can gain as a result of the growth of the industry – normally associated with a particular area </li></ul><ul><li>Supply of skilled labour </li></ul><ul><li>Reputation </li></ul><ul><li>Local knowledge and skills </li></ul><ul><li>Infrastructure </li></ul><ul><li>Training facilities </li></ul>
  16. 16. Limitation <ul><ul><li>Problems of management </li></ul></ul><ul><ul><li>Maintaining effective communication </li></ul></ul><ul><ul><li>Co-ordinating activities – often across the globe! </li></ul></ul><ul><ul><li>De-motivation and alienation of staff </li></ul></ul><ul><ul><li>Divorce of ownership and control </li></ul></ul>
  17. 17. INTERNAL & EXTERNAL DISECONOMY <ul><li>A point comes where some factors start operation in the opposite direction and the cost of production start rising. These factors are sometime called internal and external economies.. </li></ul>
  18. 18. INTERNAL DIS ECONOMY <ul><li>Internal diseconomy are those factors which rise the production of a firm as its scale of production is increased beyond a point. These are two main factors:- </li></ul><ul><li>Unwieldy Management:- A main reason for decreasing return to scale is difficulties of managing a large-sized firm. </li></ul><ul><li>Technical difficulties:- In large-sized firm a limit to the division of labour and splitting down of production process. Every machine has an optimum capacity for work and optimum proportion with other factor. If this proportion exceeded, internal diseconomies follow. </li></ul>
  19. 19. EXTERNAL DISECONOMY <ul><li>The forces which ultimately limit the expansion of an industry may be called external diseconomy. </li></ul>