KNO-HOW! ON ECONOMIES OF SCALE

Transcription

1 KNO-HOW! ON ECONOMIES OF SCALE Economies of Scale Students should be able to give examples of economies of scale and understand that they will result in lower average costs. Learning Objectives Understand the meaning of economies of scale and its application in industry Understand the limitations of economies of scale in terms of the impact on consumers (eg standardisation and choice) Understand that some firms may not wish to benefit from economies of scale and for others economies are not an option because of the nature of the business Understand that the minimum efficient scale has implications for competition and acts as a barrier to entry 1

2 Background Reading Nutter p Cordeyp Thoughts Where do many apples come from in our supermarkets? NZ Why is this peculiar? Explanation? Big is Beautiful Many big businesses gain cost advantages over smaller businesses. As businesses grow and increase production they discover a less than proportionate increase in costs These are advantages of large scale production that result in lower unit (average) costs (cost per unit) becauseac=tc/qandtcrisesslowerthanq These are called economies of scale 2

3 Economies of scale So why falling AC? Economies of scale Economies of Scale There are two types of economies of scale: Internal Economies External Economies Advantages that arise as a result of the growth of the firm Technical Financial Managerial Risk Bearing Commercial / Marketing Network 3

4 Technical the principleof multiples / balanced teams of machines Some production processes need more than one machine Different capacities May need more than one machine to be fully efficient Principle of Multiples Machine A Machine B Machine C Machine D Capacity = 10 per hour Cost = 100 Capacity = 20 per hour Cost = 50 Capacity = 15 per hour Cost = 150 Capacity = 30 per hour Cost = 200 Company A = 1 of each machine, output per hour = 10 Total Cost =? > AC =? per unit Company B =? x A,? x B,? x C,? x D, output per hour =? Total Cost =? > AC =? per unit Machine A Principle of Multiples Machine B Machine C Machine D Capacity = 10 Capacity = 20 Capacity = 15 Capacity = 30 per hour per hour per hour per hour Cost = 100 Cost = 50 Cost = 150 Cost = 200 Company A = 1 of each machine, so output per hour = 10 Total Cost = 500 > AC = 50 per unit Company B = 6A, 3B, 4C, 2D, so output per hour = 60 Total Cost = 1750 > AC = per unit 4

5 Technical increased dimensions For example bigger containers can reduce average cost. Why? Clue = emperor penguins v scorpions Increased Dimensions 1m Transport container 1 has volume of? m 3 1m Total cost (surface area) of container = or 10 per journey AC = 10 /?m 3 or? per m 3 Transport container 2 has volume? m 3 4m Double the size of the container and the total costs becomes or 40 per journey AC = 40 /?m 3 or? per m 3 Increased Dimensions 1m Transport container 1 has volume of?m 3 1m Total cost (surface area) of container = or 10 per journey AC = 10 / 3 or 5 per m 3 Transport container 2 has volume? m 3 4m Double the size of the container and the total costs becomes or 40 per journey AC = 40 / 16m 3 or 2.50 per m 3 5

6 Increased dimensions A doubling of the dimensions leads to costs increasing by 4 times but volume increasing by 8 times and therefore average costs halve. Maersk unveils design for world's largest ship The capacity and scale of the vessels is likely to change international shipping in the way that the super-jumbo is revolutionising air transport or highspeed rail has changed the way people travel across continents Financial Large firms able to negotiate bigger and cheaper finance deals Large firms able to be more flexible about finance with share finance via rights issues. 6

7 Managerial Use of specialists accountants, marketing, lawyers, production, human resources, buyers. Risk Bearing Diversification Markets across regions/countries Product ranges R&D Commercial / Marketing Large firms can negotiate favourable prices as a result of buying inbulk Large firms may have advantages in keeping prices higher because of their market power TV advertising is available to mass producers. 7

8 Example of economy of scale Daimler Chrysler own the following brands: Purchasing economies of scale can be achieved by bulk buying parts that can be used across all brands such as wiper blades Network Economies As networks become more widely used, they become more valuable to the business providing them. Examplesinclude a common language a common currency. Social networks, online auctions and air transport hubs. Here the marginal cost of adding one more user to the network is close to zero, but the resulting benefits may be hugebecauseeach new userto thenetwork can then interact, trade with all of the existing members or parts of the network. The rapid expansion of e-commerce is a great example of the exploitation of network 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 (economies of concentration) Supply of skilled labour / training facilities Local support industries and component suppliers Infrastructure, esp. transport Reputation Local or joint research and development Disintegration 8

9 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. Economies of Scale Unit Cost 82p Scale A Scale B 54p LRAC MES Output 9

10 BUT... diseconomies of Scale There are limits to the amount a business can grow where the disadvantages of large scale production leading to increasing average costs These are diseconomies of sxcale Managerial (Managers Clearly Can t Cope) De-motivation and alienation of staff Communication Co-ordination Control of workers (plus divorce of ownership and control) External Communication issues Garry Cook, the ex-ceo of Manchester City revealed a communication issue in the book The Manchester City Years by Gary James. It was 2009 and Shiek Mansour had just taken over at the club and was finalising his plans. One executive made the comment along the lines of it s all getting messy. Via the telephone and other communication lines this translated into Get Messi and a 30 million bid was tabled for the superstar. Barcelona rejected the bid. Evaluation on economies of scale Do economies of scale always improve the welfare of consumers? There are some disadvantagesand limitationsof the drive to exploiteconomiesof scale. Standardisation of products: Mass production might lead to a standardization of products limiting the amount of effectiveconsumerchoice in the market. Lack of market demand: Insufficient market demand may mean economies of scale cannot be fully exploited. Some businesses may be left with a substantial amountof excess capacity if they over-invest in new capital. Developing monopoly power: Businesses may use economies of scale to build up their monopoly power and this might lead to a reduction in consumer welfare and higherprices in the long run leading to a loss of allocative inefficiency. Protecting monopoly power: Economies of scale can be used as a form of barrier to entry when existing firms have sufficient spare capacity to force prices down in theshort run 10