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Discussion Q11

(a)

Marginal returns to variable input

When more and more units of a variable factor are applied to a fixed factor
eventually the addition to total output will decline. This is known as the Law of
Diminishing Marginal Returns.

Fixed variable Variable factor Output (Kg of Marginal output

(land) (units of labour) apples) (kg of apples)
10 0 10 10
10 1 22 12
10 2 35 13
10 3 40 5
10 4 43 3

Returns to scale

Definition: refers to the response of output to a proportional change in all inputs.

Returns to scale is a long run concept because ALL inputs can be varied (ie. No
fixed inputs).

Three types of returns to scale:

(1) Increasing returns to scale: when output increases in a greater proportion to

the changes in input

(2) Decreasing returns to scale: when output increases in a lesser proportion to

the changes in input

(3) Constant returns to scale: when output increases in the same proportion as
increases in input
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(b)

When you draw:

O O
O O
O O
O Minimum Efficient Scale (MES) / ‘Technical
Optimum’

Economies of scale (AKA Economies of mass production)

Definition: The forces that reduce the average cost of producing a product as
the firm expands the size of its output in the long run

- increasing returns to scale and decreasing costs in the long run

- remember: the prices of all inputs and all other factors are constant
- Economies of scale can explain the down -sloping part of the Long run ATC
curve

Factors that assist in lowering the average cost of production:

(1) Labour specialisation

- When there is a small # of workers they must multi-task
- When the # of workers increase then the work can be divided amongst them
- This allows specialisation as workers are able to perfect a skill
- Specialisation results in more efficiency, thus lowering cost of production

(2) Managerial Specialisation

- Large scale production can lead to better management
- In small scale production a supervisor would manage a small group of people
when he/she is capable of managing a larger group
- More workers can be hired without extra administrative costs
- A larger scale production can hire managers to do specific jobs (e.g. a
marketing expect can supervise sales and product distribution)

(3) Efficient capital

- Small firms can’t use the most efficient equipment for production because the
majority of the time these are only available to large scale production.
- Efficient machinery demands a large annual output so only large scale
producers can afford to buy this machinery and use it efficiently
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- If a small firm afford to buy efficient machinery, they would be under-using it,
therefore, it’s still inefficient and costly.

(4) By products
- Large scale producers can use leftovers to either sell to other companies to be
used.

Diseconomies of scale

Definition: When further expansion of a firm causes higher per unit costs
-Explains the up sloping side of the long run curve
- Is where output is less than proportional to the increase in inputs
- There is decreasing returns to scale and increasing costs in the long run

Main factor that causes diseconomies of scale

(1) Managerial problems

- Large scale producers may have difficulty controlling and coordinating their
operations efficiently
- This is because there may be multiple executives and management layers
- Management becomes detached from the production line
- Possibility that decisions of different managers/authority figures aren’t in sync
with each other.
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(c) TCF (Textile clothing and footwear) industry

- High quality machines that produce at a fast rate, in a capital-intensive country

like Australia (whereas in places like China it’s labour intensive, & heaps of
workers coz that’s cheaper for them…)
- Industry is quite specialised so workers become more efficient at the production
line
- By By-products are reused
E.g. Billabong makes wetsuits then uses leftover fabric to make pencil-cases

(d) Yes there are limits to scale economies due to:

(1) Government policies:

- Taxes/tariffs and import quotas are involved when the company imports or
exports materials or exports them. .
- That is, the company may have to pay taxes imposed by the Australian
government in addition to taxes that may be involved with exporting to a foreign
country
- This increases the company’s costs

(2) Transport costs:

- Company’s must pay for their goods to be shipped or transported to stores

- This also increases the company’s costs
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Random crap from my high-school notes in case ur interestis piqued =]

Economies of Scale: Internal

Internal economies of scale refer to cost savings or advantages that accrue to the
firm because it becomes more efficient in allocating its internal resources. Internal
economies of scale result from costs savings within the firm’s direct span of control.
Sources of internal economies of scale include:
 Increased specialisation of capital (which may raise total factor
productivity and labour productivity in particular. Total output will increase
as a result.)
 Increased specialisation and division of labour (which may lead to higher
labour productivity and output)
 Lower input costs (through purchasing raw materials and other
materials in bulk)
 Access to cheaper finance
 By-products or waste materials may be used from large scale
production
 R&D and technological advances may lead to new products and processes,
which may lower production costs, and increase sales of output.

Diseconomies of Scale: Internal

Internal diseconomies of scale refer to rises in production costs per unit as output
increases. Increases in plant size beyond the technical optimum will lead to rising average
costs. This may be due to the fact that:
 The management of the firm may become too complex and costly to
coordinate
 Increased output may only occur with the addition of more variable
factors
 Congestion in the production process may raise costs to the extent that
average costs keep rising and become difficult to control.

Economies of Scale: External

External economies of scale result from reductions in average costs due to factors
outside the firm’s direct control. This is largely the result of growth of the industry in
which the firm operates, causing a reduction in the LRAC curve faced by firms in the
industry. External economies of scale may result from the localisation of industry or
industrial agglomeration, where firms in a similar industry locate near each other to
reduce costs such as:
 Lower resource costs because of proximity to natural resources
 Improved transport facilities provided by the government to service the
needs of industrial or commercial complexes
 Access to cheaper power and infrastructure
 Proximity to a healthy, educated, trained and skilled labour force
 R&D as a result of industry cooperation, or government funded research
 Access to a lower cost of finance
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Diseconomies of Scale: External

External diseconomies of scale result from increases in average costs due to
factors outside the firm’s direct control. This may be due to growth of the industry in
which the firm operates, leading to a rise in the LRAC curve faced by firms in the
industry. External diseconomies of scale may also result from the localisation of industry
or industrial agglomeration, because of increasing congestion, pollution and competition
between firms:
 Higher resource costs as firms compete for available factors of production
 Increased government regulation of the industry which can add to the
compliance costs of the industry
 Higher labour costs due to skill shortages as the industry expands
 Increased congestion and pollution