Learning Objectives:

Costs in the Long Run

LO1: Distinguish between the short run and the long run

LO2: Understand why medium-sized firms are sometimes just as efficient as big firms

LO3: Understand why big firms sometimes enjoy great cost advantages

LO4: Understand why firms can sometimes be too big

CHAPTER 7

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Economies of Scale

Economies of Scale • cost advantages achieved as a result of large-scale

operations

• firms in industries characterized by assembly-line production of standardized products tend to experience declining long-run average cost

• these industries are often dominated by a few large firms

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LO3

Economies of Scale

Reasons for Economies of Scale 1. big plants are able to exploit specialization of

labour on a far greater scale than small plants

2. large-scale production encourages management specialization

3. large scale production encourages machine specialization

4. big firms enjoy pecuniary economies of scale

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LO3

Economies of Scale

Pecuniary Economies of Scale • Lower cost of borrowing

• Buying in bulk

• Selling in bulk

• Economies of scale in marketing and advertising

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LO3

Economies of Scale

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LO3

Self-Test

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Indicate the presence of either constant returns to scale or increasing returns to scale in each set of data.

LO3

Total Cost Output

Set 1 $ 30 000 175

60 000 375

Set 2 450 000 100

900 000 200

Diseconomies of Scale

Diseconomies of Scale • bureaucratic inefficiencies in management that

result in decreasing returns to scale

Decreasing Returns to Scale • the situation in which a firm’s output increases by

a smaller percentage than its inputs

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LO3

Self-Test

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Decide in each of the following cases (A–D) whether constant returns, economies, or diseconomies of scale exist.

LO3

Inputs 1 Inputs 2 Output 1 Output 2

A 6 12 240 480

B 46 92 275 650

C 18 27 500 800

D 260 540 1240 2480