Economies of scale

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Economies of scale
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Cost of production
Definition Fixed Factors ? Fixed Costs ()
Total Fixed Cost (TFC) the sum of costs which
is fixed for all levels of output
e.g. rent, interest payments for loans
Definition Variable Factors ? Variable Costs ()

Total Variable Cost (TVC) the sum of costs
which increases when output increases
e.g. cost of raw materials, electricity charges
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Cost of production
Total cost ()
Total fixed cost Total variable cost
(TFC TVC)
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Calculation of different types of cost
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Calculation of different types of cost
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Plant Firm ?
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Plant technical unit of production Firm
planning unit of production
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Long run (I) Economies of scale (P.97) the
benefits or advantages associated with larger
output levels (reflected by the decreasing
portion of the average cost curve)
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A. Economies at the Firm Level (P.103)
1. Management Economies Professional
management

• Specialization
• Higher efficiency
• Lower average cost of production

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A. Economies at the Firm Level
2. Finance Economies (P.103) Loans and
credits

• Lower interest rate

• Easy to have credit from suppliers

• Easy to raise fund

• Lower average cost of production

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A. Economies at the Firm Level
3. Marketing Economies (P.104) Buy raw
materials in bulk

• Larger discounts

Can afford expensive advertisement Lower cost per
unit
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A. Economies at the Firm Level
4. Risk-bearing Economies (P.104-5) Product
diversification
Market diversification
Diversify sources of raw materials
Reduce the risk of the firm
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A. Economies at the Firm Level
5. Research and Development (P.105)

• Improvement of product quality

• Inventions of new products

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Diseconomies of scale (P.106)
the difficulties or disadvantages
associated with larger output levels

• reflected by the increasing portion of the
  average cost curve

• the firm has become too big in size

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Diseconomies of scale
1. Management diseconomies (P.106)
E.g. A school with many classes of big size

• complicated structure
• too many departments and labour

• co-ordination problem (school picnic)

• Extra cost required for management ? ?average cost

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Diseconomies of scale
2. Marketing diseconomies (P.107)
E.g. the mobile phone market in Hong Kong

• Early stage of development

• lower cost to increase sales (in terms of
  growth rate)

• Later stage saturated market

• need extra cost in increasing sales ? ? average
  cost

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Diseconomies of scale
3. Finance diseconomies (P.107)

• extra loans from banks

• higher risk

• higher interest rate

• ? ? average cost

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Optimum output, optimum scale and optimum firm
(P.89-90)
Qm Optimum output (lowest average cost)
Optimum scale scale of having optimum
output Optimum firm firm producing optimum
output