Question

1. Describe and define the economies and diseconomies of scale for both companies in relation to the resources they use in their factors of production (Land, Labor, Entrepreneurial Talent, & Capital).
2. What types of Externalities to both firms face? How are they alike? How are they different?

3. Provide two examples of price discrimination that the firms above engage in and how that specific action would help the firms sales.

Answer 1

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

Diseconomies of scale are when the cost per unit of production (Average cost) increases because the output (sales) increases.

Growth brings both advantages and disadvantages to a business. These interact, and depending on the nature of the business and the way it is managed, decide the optimum or most efficient size for the business.

This is the area of economies and diseconomies of scale.

The most common reason for Economies of scale is that some production costs are fixed (as production increases these costs stay constant). Therefore since costs per unit (Average Costs) are calculated by dividing the cost by the number of units of output

Fixed Cost economies of scale:

1. Managerial - managers are on a fixed salary

2. Marketing - advertising, endorsements promotional events do not directly depend on quantity produced

3. Techinical - machinery, buildings etc are paid for as a fixed amount

Purchasing economies of scale:

Large firms are able to negotiate more favourable terms when buying raw materials etc.

1. Bulk buying - remember it is the cost per unit of buying in bulk not the total cost (Great example is supermarkets and local shop)

2. Financial - similar in principle to buying in bulk but this time interest rates a more favorable.

Reasons for diseconomies of scale

1. Communication - becomes more complex

2. Coordination - between departments

3. X- Inefficiency - management costs increase (non-productive costs)

4. Principle agent problem - delegating to employees who are not as committed as the owner

A negative externality occurs when an individual or firm making a decision does not have to pay the full cost of the decision. If a good has a negative externality, then the cost to society is greater than the cost consumer is paying for it. Since consumers make a decision based on where their marginal cost equals their marginal benefit, and since they don't take into account the cost of the negative externality, negative externalities result in market inefficiencies unless proper action is taken.

When a negative externality exists in an unregulated market, producers don't take responsibility for external costs that exist--these are passed on to society. Thus producers have lower marginal costs than they would otherwise have and the supply curve is effectively shifted down (to the right) of the supply curve that society faces. Because the supply curve is increased, more of the product is bought than the efficient amount--that is, too much of the product is produced and sold. Since marginal benefit is not equal to marginal cost, a deadweight welfare loss results.

3. In a competitive market, price discrimination occurs when identical goods and services are sold at different prices by the same provider.

In pure price discrimination, the seller will charge the buyer the absolute maximum price that he is willing to pay. Companies use price discrimination in order to make the most revenue possible from every customer. This allows the producer to capture more of the total surplus by selling to consumers at prices closer to their maximum willingness to pay.

In pure price discrimination, the seller will charge the buyer the absolute maximum price that he is willing to pay. Companies use price discrimination in order to make the most revenue possible from every customer. This allows the producer to capture more of the total surplus by selling to consumers at prices closer to their maximum willingness to pay.

Discounts based on occupation: many businesses offer reduced prices to active military members. This can increase sales to the target group and provide positive publicity for the business which leads to increased sales. Less publicized discounts are also offered to off duty service workers such as police.

Retail incentives: retail incentives are used to increase market share or revenues. They include rebates, bulk and quantity pricing, seasonal discounts

The airline industry uses price discrimination regularly when they sell travel tickets simultaneously to different market segments. Price discrimination is evident within individual airlines, but also in the industry as a whole. Tickets vary based on the location within the plane, the time and day of the flight, the time of year, and what city the aircraft is traveling to. Prices can vary greatly within an airline and also among airlines. Customers must search for the best priced ticket based on their needs. Airlines do offer other forms of price discrimination including discounts, vouchers, and member perks for individuals with membership cards.

The pharmaceutical industry experiences international price discrimination. Drug manufacturers charge more for drugs in wealthier countries than in poor ones. For example, the United States has the highest drug prices in the world. On average, Europeans pay 56% less than Americans do for the same prescription medications. However, in many countries with lower drug costs, the difference in price is absorbed into the taxes which results in lower average salaries when compared to those in the United States.

Academic textbooks are another industry known for price discrimination. Textbooks in the United States are more expensive than they are overseas. Because most of the textbooks are published in the United States, it is obvious that transportation costs do not raise the price of the books. In the United States price discrimination on textbooks is due to copyright protection laws. Also, in the United States textbooks are mandatory where as in other countries they are viewed as optional study aids.