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If ac is constant then mc ac and we say that

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Unformatted text preview: -specific investment to obtain a higher price. R.E. Marks ECL 2-16 2.5 Economies of Scale and Scope (Besanko pp. 173–216) 2.5.1 Economies of Scale A production process for a specific good or service exhibits economies of scale over the range of output when Average Cost declines over that range. For AC to decline as output Q increases, the Marginal Cost MC must be less than overall AC. If AC is constant, then MC = AC and we say that production exhibits constant returns to scale. If AC is increasing, then MC > AC and we say there are diseconomies of scale. $/unit MC (Q ) AC (Q ) ...... ... .. ...... .... .. .. ...... .. ..... ....... .. ...... ........ ............. ... .................. .................. .. .. .... .... ..... ............. QMES Output per period, Q R.E. Marks ECL 2-17 2.5.2 Economies of Scope Economies of scope exist if the firm achieves savings as it increases the variety of activities it performs, such as the variety of goods or services it produces. Usually defined in terms of the relative total cost of producing a variety of goods together in one firm versus separately in two or more firms. The cost implications are shown in the table: _ ___________________________ Qy TC (Qx , Qy ) _ Qx ___________________________ 100m 0 $55m 0 600m $220m 100m 600m $245m 200m 0 $60m 0 1200m $340m 200m 1200m $370m _ ___________________________ Qx is the number of adhesive message note pads produced and Qy is the number of tape rolls produced. TC (Qx , Qy ) is the Total Cost to the single firm of producing Qx pads of adhesive messages and Qy rolls of tape. R.E. Marks ECL 2-18 Given that the firm has made the investment in developing the know-how for making tape, much of that knowledge can be applied to producing related products, such as adhesive message notes. Given the up-front investment to produce tape, the additional investment needed to ramp up production of message notes is less than otherwise, and the additional costs to produce 100 million pads, on top of 600 million rolls of tape, is only $25 million, instead of the $55 million necessary from scratch. Exploiting economies of scope is often know as “leveraging core competences”, “competing on capabilities”, or “mobilising invisible assets”. R.E. Marks ECL 2-19 2.5.3 Sources of Economies of Scale and Scope • Indivisibilities and the Spreading of Fixed Costs R.E. Marks 2.5.4 Limits to Economies of Scale Why not a single mega-firm? Well: • Rising Labour Costs. — At the product level (scale). — Larger firms pay more to their workers. — At the plant and multi-plant level (scope). — More likely to be unionised? — Capital-intensive v. labour-intensive production (scale). — Lower worker turnover at larger firms. • Increased Productivity of Variable Inputs. — Increased speation. • Inventories. — Large firms carry smaller inventories as a percentage of sales than can small firms. • The Cube-Square Law and the Physical Properties of Production. • Marketing Economies. — Spreading advertising costs over larger...
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