Understanding Scale's Impact on Business and Consumers: Long-Term Cost Advantages, Study Guides, Projects, Research of Chinese Culture

Download Understanding Scale's Impact on Business and Consumers: Long-Term Cost Advantages and more Study Guides, Projects, Research Chinese Culture in PDF only on Docsity! Economies and Diseconomies of Scale This chapter focuses on long run costs, the effect of economies of scale on unit costs and the effects of economies of scale on prices and competition in markets. What are economies of scale? Economies of scale are the cost advantages that a business can exploit by expanding their scale of production in the long run. The effect is to reduce the long run average (unit) costs of production. These lower costs are an improvement in productive efficiency and can benefit consumers in the form of lower prices. But they can also give a business a competitive advantage too! Long Run Output (units per month) Total Costs (£s) Long Run Average Cost (£s per unit) 1,000 8,500 8.5 2,000 15,000 7.5 5,000 36,000 7.2 10,000 65,000 6.5 20,000 120,000 6.0 50,000 280,000 5.6 100,000 490,000 4.9 500,000 2,300,000 4.6 There are many different types of economy of scale and depending on the particular characteristics of an industry, some are more important than others. • Why can you now buy high-performance personal computers for just a few hundred pounds when a similar computer might have cost you over £2000 just a few years ago? • Why is it that the average price of digital cameras is falling all the time? The answer is that scale economies have brought down the unit costs of production and feeding through to lower prices for consumers. Internal economies of scale Internal economies of scale arise from the growth of the business itself. Examples include: 1. Technical economies of scale: a. Large-scale businesses can afford to invest in expensive and specialist capital machinery. For example, a supermarket chain such as Tesco or Sainsbury can invest in technology that improves stock control. It might not, however, be viable or cost-efficient for a small corner shop to buy this technology. b. Specialization of the workforce: Larger businesses split complex production processes into separate tasks to boost productivity. The division of labour in mass production of motor vehicles and in manufacturing electronic products is an example. c. The law of increased dimensions. This is linked to the cubic law where doubling the height and width of a tanker or building leads to a more than proportionate increase in the cubic capacity – this is an important scale economy in distribution and transport industries and also in travel and leisure sectors. 2. Marketing economies of scale and monopsony power: A large firm can spread its advertising and marketing budget over a large output and it can purchase its inputs in bulk at negotiated discounted prices if it has monopsony (buying) power in the market. A good example would be the ability of the electricity generators to negotiate lower prices when negotiating coal and gas supply contracts. The major food retailers also have monopsony power when purchasing supplies from farmers and wine growers. 3. Managerial economies of scale: This is a form of division of labour. Large-scale manufacturers employ specialists to supervise production systems and oversee human resources. 4. Financial economies of scale: Larger firms are usually rated by the financial markets to be more ‘credit worthy’ and have access to credit facilities, with favourable rates of borrowing. In contrast, smaller firms often face higher rates of interest on overdrafts and loans. Businesses quoted on the stock market can normally raise fresh money (i.e. extra financial capital) more cheaply through the issue of equities. They are also likely to pay a lower rate of interest on new company bonds issued through the capital markets. 5. Network economies of scale: This is a demand-side economy of scale. Some networks and services have huge potential for economies of scale. That is, as they are more widely used they become more valuable to the business that provides them. The classic examples are the expansion of a common language and a common currency. We can identify networks economies in areas such as online auctions, air transport networks. Network economies are best explained by saying that the marginal cost of adding one more user to the network is close to zero, but the resulting benefits may be huge because each new user to the network can then interact, trade with all of the existing members or parts of the network. The expansion of e- commerce is a great example of network economies of scale – how many of you are devotees of the EBay web site or Facebook? Illustrating economies of scale – the long run average cost curve The diagram below shows what might happen to the average costs as a business expands from one scale of production to another. Each short run average cost curve assumes a given