Question

Explain the differences between Economies of Scale and Diseconomies of Scale and explain what factors influence over them. In order to do so, you will have to use the concepts of Short and Long Run average total costs. Remember that in the Short Run Average Total Cost curve, you can find at least one of your assets as fixed and in the Long Run Average Total Cost curve, all the assets are considered variable, meaning that you are assuming the possibility of modifying your production capacity.

Answer 1

Economics of scales refers when a company starts its production, if it starts producing more products by increasing its capacity or scales then per unit cost of output decreases. On the other hand the diseconomies of scales happens when a company or a business grows so large and per unit product cost of the company increases.

As per example if Domino’s is going to introduce an automated pizza making machine then the production will increase and the cost will reduce, it is known as economics of scales. Now if it going to hire highly skilled labours to maintain this machine and if Domino’s continues to increase the investment on this then the diseconomies of scales will happen as the marginal cost will increase .

Diseconomies of scales happens in long run as in the short run the average cost curves only assume the existence of fixed costs. Where in long run there are three phases of ATC curves. I) Increasing returns to scales, ii) Constant returns to scales, iii) Decreasing returns to scales.

On the short-run the production will always be in economics of scales but in the long run the returns can be negatives as well when the ATC curve follows the decreasing returns to scales then only diseconomies of scales happen.

On the figure: 1we are going to explore the Average Cost Curve for long run.

Figure: 1

In the above figure we have drown the long run ATC curve. At initial periods the returns will always be increasing where per unit cost of products will be less as deduced in downward sloping cost curve. On the middle the costs and the returns will be same, it is known as constant returns to scales. On the extreme right where cost of production is increasing and the diseconomies of scales occurred as the ATC curve is increasing.

The factors behind Economics of Scales:

1. Introduction of new technology: If a new technology has been introduced then at first the cost of investment will be high but after sometime it will produce more products at cheaper input cost.

2. Hiring skilled labour: If a firm hires skilled labour then it will influence the production to increase the output.

3. Availability of efficient Capital: If a firm is having efficient capital to spend on its production then its operation will definitely increase

4. Availability cheaper raw materials: If raw material if available on cheaper price then it will lead to increase the production at lower cost.

Factors behind Diseconomies of Scales:

Over production: if a company produces products more than the markets demand. It can cause an loss due to over production as the average total cost will be more than the revenue.

More expenditure on resources: Firms hire more resources to increase to productions also spend more on technology but after sometime the marginal cost of resources increase. It will cause diseconomies.

Financial burden: If the financial burden continues to grow for any firm then it will cause diseconomies of scale

Corruption: If there is an internal corruption in the company then the production cost will increase and will cause diseconomies of scales.

These are the factors with causes economics of scales and diseconomies of scales.