Question

Describe an activity, process, or product of your chosen company that exhibits economies or diseconomies of scale. Describe the source of the scale economy. How could the organization exploit the scale economy or diseconomy? A good example for this discussion identifies the output (what is being produced), the inputs, and how average cost (AC; cost per unit) increased or decreased as that output and input changed over time (‘the long-run’). If AC rises when output and inputs increase from one period to the next (the long-run) then the production exhibits diseconomies of scale. When AC falls it exhibits economies of scale.

Answer 1

Sol:

Let's take the example of the smartphone industry giant Apple Inc.

Economies of Scale are the cost advantages exploited by expanding the scale of production in the long run. The effect of this is to reduce long run average costs over a range of output.

A company can benefit from both internal and external economies of scale. Internal Economies of Scale are the productivity benefits that the individual firm experiences as it grows in size. External Economies of Scale are the productivity benefits that the whole industry (all firms) experience as it grows in size.

The Types of Economies of scale that Apple could face are: Technical Economies of Scale; Due to the fact that Apple produces so many devices they can maximise the amount of goods produced to maximise their economies of scale and lower average cost per unit.

Apple’s size and the fact that most of Apples products e.g. iphone, ipad share the same components the company can buy parts such as processing chips and display screens at lower prices due to buying in bulk benefiting from Marketing Economies of scale. Any company that wants to make a tablet computer that matches the ipad’s low starting price of $499 would have to endure higher production costs.

Furthermore due to the large amount of products being produced by Apple the research and development undertaken by the company is essentially free, another example of technical economies of scale.

Another example of Marketing Economies of Scale that Apple benefits from is the large amount of advertising the company has; also due to the size of the firm advertising one product essentially advertises all other products produced by apple meaning that the cost of advertising is much lower than it would be for a smaller firm.

Apple can also benefit from financial economies of scale as new competition enters the market Apple can use their economies of scale to lower the prices of their products that competition cannot match.

The Diseconomies of scale that Apple may suffer from could be the curse of the company getting to big. Apple fears the fact that absence of better management they may no longer benefit from Managerial economies of scale and may struggle to maintain the innovation and excellence that has propelled it to such a position.

Let's understand this better with a schedule and a graph.

OUTPUT	TOTAL COST(TC)	AVERAGE COST(AC)
1	12	12
2	22	11
3	30	10
4	40	10
5	52	10.4
6	66	11

  

We can see the total cost curve goes up with additional production. But we can see that there is a difference in the trend of Average cost curve. In the long run AC curve is 'U- shaped' i.e., initially average cost falls due to increasing returns to scale(economies scale).

Then it is minimum and constant due to constant returns to scale(economies of scale are counterbalanced by diseconomies of scale).

Finally, AC rises due to diminishing returns to scale(diseconomies of scale). It is due to managerial constraint.