Question

• How can the long-run average cost (LRAC) curve be derived from the short-run average total cost (SRATC) curve?
• Describe economies of scale and diseconomies of scale.
• What are the determinants of economies of scale and diseconomies of scale, respectively?
• Using a real-world company (other than Sysco), explain the causes of economies of scale for your company.
• How would economies of scale help your company compete in its industry?

Answer 1

1. In the short run, some inputs are fixed while the others are variable. On the other hand, in the long run, the firm can vary all of its inputs.

The LRAC curve is found by taking the lowest average total cost curve at each level of outputs.

In the above figure, P, Q and R are the lowest point of outputs at various levels of average costs in short run and the big 'U' shows the long run average cost curve.

2. Economies of scale are when the cost per unit of production (AC ) decreases because the output (sales) increases.

It can be divided into two parts:-

a. Internal economies :- Refer to real economies which arise from the expansion of the plant size of the organisation. These economies arise from the growth of the organisation itself. Ex :- technical economies of scale, marketing economies of scale, financial economies of scale, commercial economies.

b. External economies :- Occur outside the organisation. These economies occur within the industries which benefit the organisations. When an industry expands, organizations may benefit from better transportation network, infrastructure and other facilities. This helps in decreasing the cost of an organisation. Ex:- economies of concentration, economies of information, economies of disintegration.

Diseconomies of scale are when the cost per unit of production ( AC ) increases because the output ( sales ) increases. It has also two parts :-

a. Internal diseconomies.:- It refer to diseconomies that raise the cost of production of an organisation. The main factors that influence the cost of production of an organisation include the lack of decision, supervision and technical difficulties.

b. External diseconomies :- It refer to diseconomies that limit the expansion of an organisation or industry. The factors that act as restraint to expansion include increased cost of production, scarcity of raw materials and low supply of skilled labourer.

3. Determinants of economies of scale are internal and external. Internal economies are controllable by managers because they are internal to the company. For example, large businesses are able to buy in bulk which in turn can lower the cost per unit of materials needed to make the product. Whereas external economies depend upon external factors which most often occurs with government aid, for example, a state often reduces taxes to attract the companies that provide the most jobs. Big state developers to convince cities to build roads to support their buildings because it saves the developers the cost of paying the taxes to build the roads that support their businesses.

Determinants of diseconomies:-

a. Poor communication

b. Lack of motivation

c. Loss of control

d. Cannibalization.

4. BATA has approximately 10000 stores in India, which sells on the order of 200 million pair of shoes a year, more than any other retailers in India. The company saves on packaging and distribution because it passes the savings onto the customers because buying in bulk is cheaper for customers because make fewer trips to the store.

5. As some businesses grow in size, their unit costs of production begin to fall because of the economies of scale which estimates the cost of advantages from business expansion. Economies of scale would help my company compete in its industry through the functionality of purchasing, marketing, administrative and research and development economies.