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MGEC40H3 (2)
Chapter 2

Chapter 2 textbook ( 4th edition)

7 Pages
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Department
Economics for Management Studies
Course Code
MGEC40H3
Professor
Jack Parkinson

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ECMC40 Chapter 2
Economies of scale & scope: exist whenever large-scale production
has a cost advantage over small processes. However,, they are not
always available. Ie landscaping & tailoring dont have substantial
scale economies.
affect the size of firms, structure of markets, they are fundamental
to diversification & merger strategies.
affect pricing, entry/exit, & the ability of the firm to secure a long
tern sustainable advantage.
Economies of scale: exists when AC declines as output increases.
exists if the firm achieves unit cost savings as it increases the
production of a good or sevice
Which implies that the MC of the last unit produced is < Ac.
( MC<AC = EOS)
Diseconomies of scale: MC>AC , AC increases as q increases.
AC curve: shows the relationship between AC and q. its a U curve. 
AC decline over low levels of output & rise over higher levels of output.
A firms AC may decline initially as it spreads FC over increasing
output. FC are insensitive to volume they should be expended
regardless of the total output.
If U shaped then small & large firms would have higher costs than
medium sized firms.
When AC are L shaped, AC decline up to the MES of production. All
firms operating at or beyond MES have similar AC. Firms producing
beyond MES can avoid diseconomies of scale by increasing their
productive capacity.
Economies of scope: exist if the firm achieves savings as it increases
the variety of goods and services it produces.
Economies of scaleEconomies of scope
- usually defined in terms of
declining AC functionsUsually defined in terms of the relative
total cost of producing a variety of
goods & services together in one firm vs
separately in 2 or more firms.
Where do scale economies come from?
1) Indivisibilities & spreading of FC:
indivisibility means that an input cannot be scaled down below a
certain minimum size even when the level of output is very small.
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Indivisibilities may give rise to FCs and hence scale & scope
economies at several different levels: product level, plant level & multi
plant level.
We have EOS due to 1) Spreading of product specified FCs (using
full capacity better than using % of it ie it yields the greatest cost
savings when used to capacity) 2) due to tradeoffs among alternative
technology: some machinery may yield to lower average total cost at
high production levels but it would be more costly at lower production
levels.
Reductions in AC due to increases in capacity utilization are
short run economies of scale in that they occur within a plant
of a given size.
Reductions due to adoption of a technology that has high
FCs but lower VCs are long run economies of scale.
Indivisibilities are more likely when production is capital intensive.
Productive capital is indivisible and therefore a source of
scale economies. As long as there is spare capacity output can be
expanded at little additional expense therefore AC falls. And cutbacks
in output may not reduce TCs by much and so AC may rise.
When most production expenses go to raw materials or labor we say
the production is materials or labor intensive.
Materials and labor are divisible and they usually change in rough
proportion to changes in output
Substantial product specific economies of scale are more likely
when production is capital intensive &
MINIMAL product specific economies of scale are likely when
production is materials or labor intensive.
2) Increased productivity of variable inputs (specialization)
division of labor refers to the specialization of productive
activities. This usually requires upfront investments
Adam Smith: the division of labor is limited by the extent of the
market
the extent of the market refers to the magnitude of demand for
these activities.
Smiths theorem suggests that individuals or firms will not make
specialized investments unless the market is big enough to support
them. Another implication is that larger markets will support a more
specialized array of activities than smaller markets can.
Also he says, specialists emerge in larger markets and the growing
firm can use them for many activities. When the market gets even
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Description
ECMC40 Chapter 2 Economies of scale & scope: exist whenever large-scale production has a cost advantage over small processes. However,, they are not always available. Ie landscaping & tailoring dont have substantial scale economies. affect the size of firms, structure of markets, they are fundamental to diversification & merger strategies. affect pricing, entryexit, & the ability of the firm to secure a long tern sustainable advantage. Economies of scale: exists when AC declines as output increases. exists if the firm achieves unit cost savings as it increases the production of a good or sevice Which implies that the MC of the last unit produced is < Ac. ( MCAC , AC increases as q increases. AC curve: shows the relationship between AC and q. its a U curve. AC decline over low levels of output & rise over higher levels of output. A firms AC may decline initially as it spreads FC over increasing output. FC are insensitive to volume they should be expended regardless of the total output. If U shaped then small & large firms would have higher costs than medium sized firms. When AC are L shaped, AC decline up to the MES of production. All firms operating at or beyond MES have similar AC. Firms producing beyond MES can avoid diseconomies of scale by increasing their productive capacity. Economies of scope: exist if the firm achieves savings as it increases the variety of goods and services it produces. Economies of scale Economies of scope - usually defined in terms of Usually defined in terms of the relative declining AC functions total cost of producing a variety of goods & services together in one firm vs separately in 2 or more firms. Where do scale economies come from? 1) Indivisibilities & spreading of FC: indivisibility means that an input cannot be scaled down below a certain minimum size even when the level of output is very small. www.notesolution.com
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