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Internal Economies of Scale. 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 – spread total costs over a greater range of output. Internal Economies of Scale. - PowerPoint PPT Presentation
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Copyright 2005 – Biz/ed
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 – spread total
costs over a greater range of output
http://www.bized.ac.uk
Copyright 2005 – Biz/ed
Internal Economies of Scale
– advantages that arise as a result of the growth of the firm
– Technical– Commercial (purchasing and
Marketing)– Financial– Managerial– Risk Bearing
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DemonstrationCapital Land Labour Output TC AC
Scale A 5 3 4 100
Scale B 10 6 8 300
•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?
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Demonstration, 2Capital Land Labour Output TC AC
Scale A 5 3 4 100 57 0.57
Scale B 10 6 8 300 114 0.38
•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•Why?
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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
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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.
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Principle of Multiples
•Some production processes need more than one machine•Different capacities•May need more than one machine to be fully efficient
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Principle of Multiples, example
Machine A Machine B Machine C Machine D
Capacity = 10 per hour
Capacity = 20 per hour
Capacity = 15 per hour
Capacity = 30 per hour
Cost = £100 per machine
Cost = £50 per machine
Cost = £150 per machine
Cost = £200per machine
Company A = 1 of each machine, output per hour = 10Total Cost = £500AC = £50 per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60Total Cost = £1750AC = £29.16 per unit
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Increased Dimensions, Example
5m
2m
2m
Transport container = Volume of 20m3
Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = £600 per journeyAC = £30m3
4m
10m
4m
Transport Container 2 = Volume 160m3
Total Cost = £1800 per journeyAC = £11.25m3
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Commercial – Purchasing and marketing
• Large firms can negotiate favourable prices as a result of buying in bulk (purchasing)
• Large firms may have advantages in keeping prices higher because of their market power (marketing)
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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
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Managerial
–Use of specialists – accountants, marketing, lawyers, production, human resources, etc.
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Risk Bearing– Diversification– Markets across regions/countries– Product ranges– R&D
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Economies of Scale
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
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Economies of ScaleUnit Cost
Output
Scale A
Scale B
LRAC
MES
82p
54p
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Copyright 2005 – Biz/ed
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