Question

QUESTION TWO [20]

“When economies of scale are substantial, larger firms can achieve lower average costs of production or distribution than their smaller rivals, giving the larger firms a permanent competitive advantage in some industries. By the same token, when diseconomies of scale are operative, larger firms can suffer a greater loss when compared to their smaller rivals. Smaller firms are then able to translate the benefits of small size into a distinct competitive advantage.” In terms of the above statement:

2.1. Explain one (1) factor that contributes to smaller firms having a competitive advantage over larger firms. (10)

2.2 Discuss one (1) source of economies of scale that provides large firms with a permanent competitive advantage over their smaller rivals.

Answer 1

1. According to the given statement, larger firms have a competitive advantage in the market as compared to smaller firms, but not all the time. Smaller firms can also have an advantage in the competitive market that is generally for short-run. One of the factors that contribute to the competitive advantage of a smaller firm is consumer taste and preferences. Larger firms have a high volume of inventory to sell in the market, while smaller firms have limited inventory. When consumers taste and preferences changes due to change in the trends, larger firms face a large amount of unsold inventory, which will lead to decrease the revenue and increase the loss. At the same time, smaller firms have a small amount of inventory, and the loss arises due to unsold inventory can be compensated by purchasing products that are in trend as small firms can switch their production of different products and service. In comparison, larger firms face difficulties and high cost of shifting from one product to another.

2. Larger firms generally have a competitive advantage due to economies of scale. One of the sources of economies of scale that provides a permanent competitive advantage is patent. A patent gives an exclusive right to a producer on the products or services or technology that he produced or invented for the first time in the market. The patent helps to gain more from the invention as it gives monopoly power that makes it a single seller of a specific product or service, and a producer with patent right can earn money by allowing other people to use that specific technology by paying for it. Therefore, larger firms use patent right to have a permanent competitive advantage.