Economies of Scale

Long-run Cost Curves

• Economies of Scale
• Long-run cost curves show minimum cost
in an ideal environment.
Cost Elasticity and Economies of Scale

• Cost elasticity is εC = ∂C/C ÷ ∂Q/Q.

• εC < 1 means falling AC, increasing
returns.
• εC = 1 means constant AC constant
returns.
• εC > 1 means rising AC, decreasing
returns.
Long-run Average Costs
 Minimum Efficient Scale
• Competitive Implications of Minimum Efficient
Scale
– MES is the minimum point on the LRAC curve.
• Competition is most vigorous when:
– MES is small in absolute terms.
– MES is a small share of industry output.
– Disadvantage to less than MES scale is modest.
Transportation Costs and MES
– Terminal, line-haul and inventory costs can be
important.
– High transport costs reduce MES impact.
 Firm Size and Plant Size
• Multi-plant Economies and Diseconomies of
Scale
– Multi-plant economies are cost advantages from
operating several plants.
– Multi-plant diseconomies are cost disadvantages
from operating several plants.
 Economics of Multi-plant Operation: an
Example
• Plant Size and Flexibility
 Learning Curves
• Learning Curve Concept
– Learning causes an inward shift in the LRAC curve.
– Learning curve advantages are often mistaken for
economies of scale effects.
• Learning Curve Example
• Strategic Implications of the Learning Curve
Concept
– When learning results in 20% to 30% cost savings,
it becomes a key part of competitive strategy.
 Economies of Scope
• Economies of Scope Concept
– Scope economies are cost advantages that stem
from producing multiple outputs.
– Big scope economies explain the popularity of
multi-product firms.
– Without scope economies, firms specialize.
• Exploiting Scope Economies
– Scope economics often shape competitive
strategy for new products.
 Degree of Operating Leverage
– DOL=Q(P-AVC)/[Q(P-AVC)-TFC]
– DOL is the elasticity of profit with respect to
output.