Economies of Scale Asst Prof Dr Serdar AYAN

Economies of Scale Asst. Prof. Dr. Serdar AYAN

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 – spreads total costs over a greater range of output.

Economies of Scale • Internal Economies of Scale advantages that arise as a result of the growth of the firm – Technical – Commercial – Financial – Managerial – Risk Bearing

Economies of Scale • External Economies of Scale – the advantages firms can gain as a result of the growth of the industry – normally associated with a particular area • Supply of skilled labour • Local knowledge and Skills • Infrastructure • Training facilities

Economies of Scale Capital Land Labour Output TC Scale A 5 3 4 100 82 Scale B 10 6 8 300 164 AC Assume each unit of capital = 5 TL, Land = 8 TL and Labour = 2 TL Calculate AC for the two different ‘scales’ (sizes’) of production facility What happens and why?

Economies of Scale Capital Land Labour Output TC AC Scale A 5 3 4 100 82 0. 82 Scale B 10 6 8 300 164 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. Why?

Economies of Scale • Internal: 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

Economies of Scale • 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,

Economies of Scale • Principle of Multiples: • Some production processes need more than one machine • Different capacities • May need more than one machine to be fully efficient

Economies of Scale • Principle of Multiples: EG Machine A Machine B Machine C Machine D Capacity = 10 per hour 20 per hour 15 per hour 30 per hour Cost = 100 TL per machine Cost = 50 TL per machine Cost = 150 TL per machine Cost = 200 TL per machine

Economies of Scale • Principle of Multiples: EG Machine A Machine B Machine C Machine D Capacity = 10 per hour 20 per hour 15 per hour 30 per hour Cost = 100 TL per machine Cost = 50 TL per machine Cost = 150 TL per machine Cost = 200 TL per machine Company A = 1 of each machine, output per hour = 10 Total Cost = 500 TL AC = 50 TL per unit

Economies of Scale • Principle of Multiples: EG Machine A Machine B Machine C Machine D Capacity = 10 per hour 20 per hour 15 per hour 30 per hour Cost = 100 TL per machine Cost = 50 TL per machine Cost = 150 TL per machine Cost = 200 TL per machine Company A = 1 of each machine, output per hour = 10 Total Cost = 500 TL AC = 50 TL per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60 Total Cost = 1750 TL AC = 29. 16 TL per unit

Economies of Scale Increased Dimensions Transport container 1 = Volume of 20 m 3 2 m 2 m 5 m Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 600 TL per journey AC = 30 m 3 TL Total Cost = 1800 TL per journey AC = 11. 25 m 3 TL 4 m 4 m 10 m Transport Container 2 = Volume 160 m 3

Economies of Scale • Commercial • Large firms can negotiate favourable prices as a result of buying in bulk • Large firms may have advantages in keeping prices higher because of their market power

Economies of Scale • Financial • Large firms able to negotiate cheaper finance deals • Large firms able to be more flexible about finance • Large firms able to utilise skills of merchant banks to arrange finance

Economies of Scale • Managerial –Use of specialists – accountants, marketing, lawyers, production, human resources etc

Economies of Scale • Risk Bearing – Diversification – Markets across regions/countries – Product ranges – R&D

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