Question

Size of the firm is closely related with competitiveness of the firm, particularly in a global market. Using the concept of minimum efficient scale (MES) at long run average cost curve explain why firms in some industries can have market power to set price strategically than firms in other industries.

Answer 1

MES refers to the minimum efficient scale. It refers to the lowest point on the LAC of a firm. A point before this will have a situation of economies of scale and after this point there will be diseconomies of scale. After achieving this point, increase in production will be accompanied with increasing average cost.

Every industry works differently and thus has different number of players. There can be a number of reasons that include specialization, discounts, bulk production due to rise in demand. All these factors reduce the LAC to the lowest point possible.

The size of market and its demand (product demand) will determine the number of players in the industry. The MSE point is the point where the production cost is the lowest. Some firms in an industry will have better technologies, specialized skills which will improve the quality of the product at the same competitive price. The demand for this firm’s product will increase which will lead to an increase in the market share of this brand. When such an activity happens, this firm will become the price setter in the industry since it has a huger market share.

Some industries are huge with a number of players. No firm has a huge enough market share that it can influence the industry in anyways nor its prices. And hence every firm thus functions at the competitive price and no single firm determines or influences prices.

Eg is company X which is a firm in the Automobile industry. There are a number of other firms in the automobile industry. The demand is also huge which lets the firm operate. Now assume company X innovates the product makes it better at the competitive price, the demand for its products will increase and it may setup more factories or offices in different countries. This will increase the presence of company X in the global markets and thus be able to impact price.