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Internal Economies of Scale
  1. 8. Location & Economies of scale.pdf
  3. Achieving Economies of Scale – Strategy Tools From
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8. Location & Economies of scale.pdf

Teaching Vacancies. Head of Economics Clifton College, Bristol. Variable costs v Q include the costs of raw materials and other industry services, labor, energy, taxes, and transport:. Sum over all inputs to find total variable input costs.

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  • Economies of Scale, Transport Costs and Location.
  • What Are Economies of Scale??
  • Again, remember that for service sector businesses, at least some of the labor is a fixed cost because someone must be present and paid at all times when the shop is open, even if nothing is sold. Taxes and transport costs will be detailed later. Divide through by Q to show that for our example, variable costs are constant per unit output:. Profit is the surplus of revenues over costs:.

    Increasing returns to scale is when profits per unit rise as quantity rises. Profits per unit are:. Formula 7 highlights the three main sources of increasing returns: higher prices paid, more output per plant, and lower marginal costs.

    What Are Economies of Scale?

    Increases in output price P or reductions in input prices P i or P E , or wages w , are called pecuniary sources of increasing returns to scale. But those elements are not under the control of an individual firm. They are not, therefore, sources of increasing returns to scale that are internal to an individual firm. They are usually affected, however, by the numbers of firms in a location, and thus these are often the sources of external returns to scale known as agglomeration economies of scale. Economies of scale can be classified a dozen ways:. Type of economy of scale:.

    External or agglomeration economies 4- 12, above arise from an increase in the economic activity in the location which cause, through 8 various mechanisms, industry-wide costs to fall or revenues to rise. Localization economies , arise when there are large numbers of firms in that same industry and same place.


    Urbanization economies 8- 11 arise from the presence of a large number of different industries in the same place. Static economies of scale arise contemporaneously. Firms that supply shopping goods where customers do the transport enjoy more sales and higher revenues by locating close together. Shoppers are more attracted to the sites where there are many shops than few, because the act of shopping entails the fixed cost of driving to a store. The shoppers' choices to minimize transport costs per shop give rise to benefits to the stores that locate where lots of other stores are.

    The more shops there are in the same place, the higher are sales Q , prices P o , and the higher are revenues. All other localization economies arise from industry-wide cost reductions. The growth of supporting facilities and services is encouraged by a firm's large scale of operation. As a firm's scale of operations gets larger, it often becomes worthwhile for other firms and local governments to provide it with unique services that result in direct or indirect cost advantages. If a firm builds a large plant in a particular area, an improvement in highways and expanded transportation services may soon follow.

    Smaller suppliers that find a large part of their sales going to the larger firm may move closer to reduce transportation costs. All of these developments could result in lower per-unit costs for the large firm. Larger firms have a cost advantage over their competitors.

    Not only does a larger plant gain from economies of scale, it also will produce more. Companies often use this advantage as a competitive strategy by first building a large plant with substantial economies of scale, and then using its lower costs to price aggressively and increase sales volume. Large economies of scale cause the firm's long-run average total cost curve to fall over a sizeable range as output is increased.

    In industries where the technology of production leads to economies of scale, the long-run average total cost curve for a single firm may fall over almost the entire range of output covered by the industry demand curve. When long-run average total cost falls in this fashion, it is possible for a firm that gets into this market ahead of others to obtain a competitive advantage.

    The ever lower per-unit costs it realizes at higher and higher levels of output permit the firm to charge a price lower than the average per-unit costs that prevail at lower levels of output. In this way, the firm is able to satisfy the entire market demand at a price below that which potential new rival firms must charge when getting started.

    These new firms would thus not be able to charge a price low enough to compete for sales with the established firm. Therefore, the established firm is able to keep rivals out of the market and maintain a monopoly position. According to David Kass in his article, "Economies of Scope and Home Healthcare," economies of scope exist if a firm can produce several product lines at a given output level more cheaply than a combination of separate firms each producing a single product at the same output level.

    Economies of scope differ from economies of scale in that a firm receives a cost advantage by producing a complementary variety of products with a concentration on a core competency.

    While economies of scope and scale are often positively correlated and interdependent, strictly speaking the benefits from scope have little to do with the size of output. For instance, in the paper products industry it is common for large firms to produce their own pulp, the primary ingredient in paper, before manufacturing the paper goods themselves.

    Achieving Economies of Scale – Strategy Tools From

    However, smaller firms may have to purchase pulp from others at a higher net cost than the large companies pay. The savings from producing both pulp and paper would be an economy of scope for the large producers, although the large companies probably also have economies of scale that make it feasible to invest in pulping operations in the first place.

    In another example, banks have economies of scope when they offer a variety of related financial services, such as retail banking and investment services, through a single service infrastructure i. Clearly, the costs of providing each service separately would be much greater than the costs of using a single infrastructure to provide multiple services.

    Research concerning hospitals has suggested that other types of services, such as pediatric care, may have economies of scope. With increasing competition and emphasis on service, economies of scope are necessary for hospitals to provide these services profitability. When a firm grows beyond the scale of production that minimizes long-run average cost, diseconomies of scale may result.

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    When diseconomies of scale occur the firm sees an increase in marginal cost when output is increased. This can happen if processes become "out of balance," or when one process cannot produce the same output quantity as a related process. Diseconomies of scale also can occur when a firm becomes so large that:. James C. Revised by R. Anthony Inman.