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 CapitalLandLabourOutputTCAC Scale A Scale B 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?

Economies of Scale CapitalLandLabourOutputTCAC Scale A Scale B 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 Increased Dimensions: e.g. 5m 2m Transport container = Volume of 20m 3 Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = $600 per journey AC = $30m 3 4m 10m 4m Transport Container 2 = Volume 160m 3 Total Cost = $1800 per journey AC = $11.25m 3

Economies of Scale Marketing 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 Lower advertising cost per unit

Economies of Scale Financial Large firms able to negotiate cheaper finance deals- Lower interest rates 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 Technical economies Diversification and increased specialisation Indivisibility of machinery (big firm can take advantage of large machinery. E.g. Coke’s bottling machine Vs Mr Johnson’s home brew 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

Table for Harvey’s Bikes Year of production Output- Bikes produced in 1 year TC- How much all costs will be to Harvey Bikes AC- Cost per unit of output , , ,000, ,000,000

Year of productionOutput- Bikes produced in 1 year TC- How much all costs will be to Harvey Bikes AC- Cost per unit of output , , ,000, ,000, Create a graph to show the above information

AC Output

From your graph….. 1. What has happened between 2008 and 2010? 2. Give three possible causes for the trend you gave in question 1? 3. What has happened in 2011? Give possible reasons for this change