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Section 3 - Business economics - economies and diseconomies of scale -…
Section 3 - Business economics - economies and diseconomies of scale
Economies of scale
Basics
Average cost to firms is high if they don't make much output
In long run - more things made leads to a lower average cost
Economics of scale - cost advantages of production on a large scale
Internal
Technical
Law of increased dimensions - larger warehouses allow for more storage and production space
Advanced machinery can lower average costs
Purchasing
Purchasing large quantities of raw materials can lead to discounts
Large firms are important customers of suppliers
Managerial
Specialist manages can be employed which leads to better decision making
Number of manages dones't depends directly on prodution scale, twice the production doesn't needs twice the managers
Financial
Large firms can borrow at lower interest rates
Loaning to them is seen as less risky
Risk beairng
Larger firms can diversify and have a more predictable demand
Large firms can take more risks and absorb failure costs more easily
Marketing
Advertising is fixed cost, spread over more units leads to a lower cost per unit
Cost per product of advertising several products may be lower than just one
Changes within a firm
External
Changes outside a firm, within an industry
Large companies in an area may lead to infrastructure improvements being implemented
Supplies may decided to locate in the same area as large firms to reduce transport costs
Better training facilites leads to firms spending less to train
Monopoly power
As a firm's average cost falls, it can sell the product at a lower price and undercut competitors
Firms can gain a larger market share
Firms can eventually force their competitors out of business
Diseconomies of scale
Internal
Wastage can increase as its harder to manage productivity
Coordination becomes harder between departments
Cause average cost to rise as output rises
External
As a whole industry becomes bigger, price of raw materials may increase due to larger demand
Buying large amounts of raw materials may not be cheaper if it requires more transportation
High fixed costs
Huge economies of scale in industries with high fixed costs but low variable costs
Robot based assembly lines are very expensive to set up, but reduce labour costs. High fixed cost, low variable
Some firms taking advantage of large economies of scale may force others to follow or shut down
Revenue
Total revenue - total amount of money received in a time period
Revnue = quantity X price
Average revenue is total revenue / quantity
Demand curve
Revnue is area under the demand curve
Price taker
Perfectly elastic demand
No power to control the price it sells at
If firms inreases the price then quantity demand drops
No reason to decrease the price as same quantity would see at higher price
Price maker
Downward sloping demand curve
Price makers have power to set the price
To increase sales, prices must
reduce