Question

5. (4 pts) Define ‘economies of scope’ and ‘economies of scale’. Discuss how they are similar. Discuss how they differ. Explain how either could be used to sustain positive economic profits (up to and including a monopolistic position).

Answer 1

Economies of scale: It refers to the fall in average cost of production of goods by the firm, as its scale of operations increases. E.g. specialization of labor in production activities

Economies of scope: It refers to the fall in average cost of production of goods by a firm when it undertakes production of multiple goods or multiple types of goods under its roof. E.g. a car manufacturing company will experience reduced average costs if it starts producing tires too

How they are similar: Both lead to reduced average cost of production

How they differ: In the reason why average cost falls. Under economies of scale it occurs because of increase in scale of operations while under economies of scope it occurs because of taking multiple production lines under its roof

These concepts can be used to sustain positive economic profits as they help reduce AC as Q increases.

Since profits are calculated as (P-AC).Q

A fall in AC as Q increases leads to increase in economic profits.

However, such a scenario is possible only in case of monopolistic or monopolistic competitive firms because in case of perfect competition all firms will experience the same falls in AC and thus everyone will earn profits and then reach a point of positive normal profits