economies of scale asst. prof. dr. serdar ayan. economies of scale the advantages of large scale...
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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 ACScale A 5 3 4 100 82
Scale B 10 6 8 300 164
Assume each unit of capital = 5TL, Land = 8TL and Labour = 2TLCalculate AC for the two different ‘scales’ (sizes’) of production facilityWhat happens and why?
Economies of Scale
Capital Land Labour Output TC ACScale 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 fallenDon’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
Capacity = 20 per hour
Capacity = 15 per hour
Capacity = 30 per hour
Cost = 100TL per machine
Cost = 50TL per machine
Cost = 150 TL per machine
Cost = 200TL
per machine
Economies of ScalePrinciple of Multiples: EG
Machine A Machine B Machine C Machine D
Capacity = 10 per hour
Capacity = 20 per hour
Capacity = 15 per hour
Capacity = 30 per hour
Cost = 100TL per machine
Cost = 50TL per machine
Cost = 150TL per machine
Cost = 200TL
per machine
Company A = 1 of each machine, output per hour = 10Total Cost = 500TLAC = 50TL per unit
Economies of ScalePrinciple of Multiples: EG
Machine A Machine B Machine C Machine D
Capacity = 10 per hour
Capacity = 20 per hour
Capacity = 15 per hour
Capacity = 30 per hour
Cost = 100TL per machine
Cost = 50TL per machine
Cost = 150TL per machine
Cost = 200TL
per machine
Company A = 1 of each machine, output per hour = 10Total Cost = 500TLAC = 50TL per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60Total Cost = 1750TLAC = 29.16TL per unit
Economies of Scale
Increased Dimensions
5m
2m2m
Transport container 1 = Volume of 20m3
Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 600TL per journeyAC = 30m3 TL
4m
10m
4m
Transport Container 2 = Volume 160m3
Total Cost = 1800TL per journeyAC = 11.25m3 TL
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
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