MA in Media & Communication

Media Economics & Enterprise Management

By

Feroz Khan Shaikh

Id no: 2010MAMED1006

Manipal University- Dubai

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ABSTRACT

In economics, markets are classified according to the structure of the industry serving the
market. Industry structure is categorized on the basis of market structure variables which are
believed to determine the extent and characteristics of competition. Those variables which have
received the most attention are number of buyers and sellers, extent of product substitutability,
costs, ease of entry and exit, and the extent of mutual interdependence [Baumol, 1982; Colton, 1993].

According to Gregory Mankiw in Principles of Economics “A market is a group of buyers and

sellers of a particular good or service. The buyers of a group determine the demand for the
product, and sellers as a group determine the supply of the product.”

Markets can be in the form of an organized activity, such as where a buyer and seller meet a a
specific time and place, and a third person will help them to set the prices and arrange for it
sale There is another form of a market which is less organized; here the sellers are in different
location and do not meet each at a common place, and at any particular time. There is third
person or an auctioneer who decides the price. Each seller post a price and each buyer decides
how much to buy at each store. Even though the market is not organized, a group of buyers and
sellers forms a market.

n the traditional framework, these structural variables are distilled into the following
taxonomy of market structures:

In economics, market structure (also known as market form) describes the state of a market
with respect to the degree or intensity of competition among buyers on one side and among
sellers/ producers on the other side. Market micro-structure is also distingiushed by the
process of price discovery, the differentiation / homogeiety of products,the process of
bidding, the trade/ exchange settlement mechanism, the symmmetry or assymetry of the
dispersal of market relevant information among the individual parties to each transaction of

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trade/ exchange. This is the subject of market morphology. Based on the various
chracteristic status/ values, different types of markets are given different names like perfect
competition, monopoly. oligopoly, duopoly, monopolitic competition, oligopolistic
competition., monopsony, oligopsony etc. but each defines the term a bit differently.
Economists look at the overall market structure with the goal of defining and predicting
consumer behavior Market structure, or market form, competitive structure, is the state of a
market with respect to competition, measured by number and distribution of firms,
indicating the competitivity of the market.
Major market structures from most competitive to least:

QUESTIONS

I) What are Supply and Demand? How do they work together to maintain a balanced
economic system.

If you are buying grocery for your home, you will notice the prices of goods go up and down
so often. Have you ever wondered, what could be the reason? Well, one of the reasons is the
law of supply and demand. To understand supply and demand we must first understand what is
market?

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According to Gregory Mankiw in Principles of Economics “A market is a group of buyers and
sellers of a particular good or service. The buyers of a group determine the demand for the
product, and sellers as a group determine the supply of the product.”

Markets can be in the form of an organized activity, such as where a buyer and seller meet a a
specific time and place, and a third person will help them to set the prices and arrange for it
sale There is another form of a market which is less organized; here the sellers are in different
location and do not meet each at a common place, and at any particular time. There is third
person or an auctioneer who decides the price. Each seller post a price and each buyer decides
how much to buy at each store. Even though the market is not organized, a group of buyers and
sellers forms a market.

Let us look at example; a new car is to be introduced in India. The car maker has to decide
what is the target market, are they looking at rich people, who like a car with all facilities, or a
middle income person who looks for a an economic car, pretty basic. After this, the makers
must decide how many of the car to manufacture so they are not stuck with too many. Then
they will decide how to charge for the car- what will an average price, a buyer willing to pay.

They would need to charge enough for the car to cover the costs of manufacturing,
advertisements, services, warranty etc. Since they also wish to make a profit on the car, they
will also want to figure that cost as well, what will be the break even. If they are introducing a
car for an middle income people, and they found out that it is not affordable or its not worth the
price, there will be too many or an oversupply. If they prices are low, cost will not be covered
and little profit will be made as if it may sell very well. The company would lose money and
may even have to close. As the economics principles states, usually as price rise, supply or
amount of a product increases and as prices fall, the supply decreases as more people will be
able to afford the product.

Demand

If the manufactures are able to develop a truly excellent car, there will be probably a high
demand for the car. Also, if it is well advertised, more people will come to know and will be
interested to buy. If another car maker entering the market, with a better car, more economical,
the demand for will drop and thus the price would to drop to sell it.

From the above example, let us analyze how a market works, if the price of car rose Rupees
20,000, people buy less car. People might go for a two wheeler instead. If the price of car fell
Rupees 20,000, people will buy more cars. There is a relationship between price and quantity
demanded and this is called law of demand. “When the price of good rises, the quantity
demand of the good falls, and when the price falls, the quantity demanded rises”.

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 Let us assume a new rent a car company buy 1 car each month to improve its business, think if
he gets a car half the price he buy two, if he gets a car one third of the price, he might buys
three cars. And if the price goes up he will be buying less no of cars. When the prices reach at
an unexpected level, he might stop buying cars. This a demand schedule, shows “a relationship
between price of a good and the quantity demanded, holding constant everything else that
influences how much consumers of the good want to buy.”

Price Quantity Total Quantity

Demanded
1 Lakhs 1 1
50,000 1 2
25,000 1 4
( Table 1: Demand Schedule)

120,000
100,000
80,000
Price

60,000
40,000
20,000
0
1 2 4
Quantity demanded

(Figure : Demand curve)

“The Demand curve is defined as the relationship between the price of the good and the
amount or quantity the consumer is willing and able to purchase in a specified time
period, given constant levels of the other determinants--tastes, income, prices of related goods,
expectations, and number of buyers”

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 120000

100000

80000 I
Price

60000

40000
II
20000

0 D
1 2 3 4 5
Quantity demanded

(Figure2- change in quantity due to change in price)

A shift in the demand curve is caused by a change in any non-price determinant of demand.
The curve can shift to the right or left.

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 6
5
4
Price

3
2
1
0
1 2 3 4 5
Quantity demanded

Figure 3 (A demand curve shits to the right when quantity is increased)

A rightward shift represents an increase in the quantity demanded (at all prices), whilst a
leftward shift represents a decrease in the quantity demanded. Here are several determinants of
individual demand. Let us consider our previous example of a rent a car company to buy cars,
each month, and what affect their decision.

Price: If the price rises, they would buy fewer cars, or even stop buying new cars. If the price
of cars fell, buyers will buy more cars. When the prices of good rises, the quantity demanded of
the goods will also fall.

Income: During recession in Dubai, many people lost the jobs and cutting the expenses from
food, travel etc. People stop going to restaurants when they lost the jobs. The demand for
eating outlets falls when incomes falls.

Price of related goods: Suppose the price of motorbikes falls. According to the law of demand
well will buy more motorbikes. And most probably we will buy fewer cars. When a fall in
price of one good reduces the demand for another good, the two good are substitutes. If the
price of substitute good increases, then the demand for the other good would increase as
consumer switches their consumption patterns.

Substitutes and complements:

“When a fall in the price of one good reduces the demand for another good, the two goods are
called substitutes: Example: DVDs and VHS are substitutes since with the decrease in price of
DVDs, will have VHS almost out of the market, thus increasing more of DVDs.

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 “When a fall in the price of one good increases the demand for another good, the two goods are
called complements”. Ticket price for cinema and Popcorn are complements when there is fall
in price for Cinema tickets, we increase the consumption of Popcorns.
.
Tastes: It is an obvious that if you are used to drive a car not motorbike, you will buy a car
even if the price goes up a little.

Expectations: Your expectations also determine the demand for a good or service today. Think
about someone getting promoted as a manager, he will definitely spend more money buying
luxury goods to maintain some social status. Or if you are expecting a bonus next month, you
will most probably spend more money for grocery.

Intangible Goods, a demand for an intangible good can be based of a future event or a future
contract like , Reliance stock price in Jan 2011, Value of shares in $ as on June 2011, Price of
wheat during monsoon season in India.

Inferior goods are type of good for which demand declines as the level of income or real GDP
in the economy increases. This occurs when a good has more costly substitutes that see an
increase in demand as the society's economy improves. Example, taking buss pass in a public
transport and forgo their own forms of transportation in order to cut down costs. Normal goods
are “the one that experiences an increase in demand as the real income of an individual or
economy increases” Example might be buying a brand new car; when someone gets promoted.

Diminishing marginal utility: Let us look at example where a buyer, buys more and more pairs
of black trousers, his/her increase in satisfaction with having yet another new pair falls, so the
price he is willing to give up also falls. After a few new pairs, the thrill is gone (or at least it's
declining).

Supply

In a market, sellers identify the quantity to be supplied depending on the demand. The law of
supply states when there is an increase in price of a product, the supplier want to produce and
supply more. As they produce more quantity the total cost increase proportionately, and profit
increases. The ratio to the total cost and quantity of the product increases; this is known as the
marginal cost of production. In a market, total supply represents the quantities suppliers are
willing to sell over a range of prices for any give time period. Here, the relationship between
price and supply is positive. Factors that determine important in determining supply behavior
include, the number of sellers producing and selling the same product, Technological
advantage a seller have with others, Price of Raw Materials used for production, Weather, Price
of other goods could be produced.

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 Price Quantity Total Quantity Supplied

1 1 1
2 1 2
3 1 3
4 1 4

(Table 2: Supply schedule)

The supply schedule shows at each price, the additional number of units that would be offered
(quantity) and the total number of units that would be offered (total quantity supplied). Supply
schedule can show, at each price, the total number of units that would be profitable to be
offered.

4.5
4
3.5
3
2.5
Price

2
1.5
1
0.5
0
1 2 3 4
Quantity supplied

Figure 4 ( Supply curve, as production increases, the additional (marginal) cost of production also increases)

Market supply, when they are new firms entering a market the supply increases and market
price for a good goes down, sometimes the supplier may decide deliberately to limit supply by
controlling production through the use of quotas, this will reduce the supply and force the price
upwards. When more suppliers are entered the ranges of choices are also improved.

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 4.5
4 S
3.5
3 II
2.5
Price

2
1.5 I
1
0.5
0
1 2 3 4
Quantity supplied

(Figure5- change in quantity due to change in price)

If there is a change in price will affect the quantity that is profitable. As price rises, more unites
are Profitable and supplier will increase the quantity supplied.

Supply curve can shit to the right when a decline in labor cost reduces the cost f producing each
unit of the good, and a greater quantity of units is profitable at each price. An improvement in
technology will reduce no of resources required for each unit, and thus reducing the cost o
producing each and increasing unit profitable at each price. If sellers believe the future price is
now lower than previously, they will choose to bring in the units which they kept in inventory
for sometime. Supply curve can shit to the right when the labor cost increases, and producing
each unit is expensive. A decline in technology, increases number of resources, increasing the
cost of production of each unit, and decreasing the units produced.

The law of supply and demand will move toward a point that equalizes quantities supplied and
Demanded, a corrective action will take place in any market during sometime. Let us look at
the example of Dubai Real-estate market, when the prices of property were higher, more
developers, resellers where entering the market, and there was surplus of property available in
the market. This had led to a corrective action of drastically reducing the Rents/ Sales Price.

A market attains equilibrium when both the demand and the supply intersect each other. This
can be shown in a curve. Here in the below curve, as we can see, the demand and the supply
meet at a point this is the point where the market attains equilibrium. This is the optimum point
where both the consumer and the supplier get maximum satisfaction and profit out of the
product respectively. It is the point where the market is in a stable condition.

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 6

Price
5

0
1 2 3 4

Quantity

Figure6- Equilibrium)

When a market reaches this point, it tends to stay at this point. If there is a surplus or shortage,
the Market will move the price towards an equilibrium point. There are times when
government intervenes and fix a price below the market equilibrium price. (Examples are
lottery, cigarette etc). Sellers sometimes have excess in quantity supplied or a surplus. The
seller suppose has five units supplied to the market at a price of $4, the quantity demanded is
only 2 units. Here the price is high for 5 units to be profitable, so only 2 units would be
purchased in the market. Surplus results in an unplanned increased in inventory levels. The
seller need to decrease the amount offered and increase the quantity demand, until a surplus no
longer occurs. “When a price is below the equilibrium price, the quantity demanded exceeds
the quantity supplied.” A shortage is when a supplier will raise the price and many buyers want
to buy them, it will move toward the equilibrium. In a market where quantity demanded is 5
units, quantity supplied 2 units. ( if the supplier has only first two units, it will be low enough
to be profitable, at $2, suppose if the supplier has 4 units at the same price, the buyer will be
satisfied.

Example, a person who bought a home in Dubai during 2006-2007, at that time demand for the
homes in Dubai was quite high, and the supply was not enough to meet the requirements. There
were substitutes for a new home, such as an apartment or renting a house.
As the need for home rose, the sellers were selling homes for a little higher price because they
knew people are looking to purchase. But after recession, and when more expatriates have left
Dubai, the supply was great, sellers found themselves lowering the price to try and have their
home picked over another substitutes.

“A change in quantity supplied, means a movement along the supply curve, corresponding to a
change in price. A “change in supply” refers to a shift of the entire supply curve, caused by a
change in something other than a change in price (i.e., the determinants of supply”
(http://www.csun.edu/bus302/Lab/ReviewMaterial/micro3.pdf)

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 There are many factors that caused a change in the supply and demand for homes in Dubai.
Supply was influenced by the increasing number of people coming to Dubai, Surrounding area,
facilities provided. At that time when looking for a home, there were several available in the
area but the purchasing demand was very competitive. To compete with the supply, the price of
home as well as some incentives like giving more key money had to be offered in order to meet
the purchasing demand. When the demand for homes was high and supply was low, many
Developers, Resellers entered the market and sold the homes for a higher price. But currently
in Dubai, where the supply is quite high, and the demand is very low, Sellers are selling the
homes at much lower price with some incentives from their side like more discounts on full
payment, maintenance free etc. In the current market, the supply is high due to foreclosures,
job loss, and rise in cost of living.

II) As a consumer, study a media firm. Consider the following:

a) Production Function

“A production function is a mathematical relationship between the inputs a firm uses and the
output the firm generates”. Let us assume there are three basic inputs in a media company
workers (staff) , capital ( machines) and technology”. Technology here can be visual editing,
use of lights, re-recording etc.

Let us look at Digital Media industry; every part of part of the enterprise has a production
function. So, when you ask different parts of the enterprise the same questions you will get
different answers. The main functional of a digital media company is to create the technology
for digital media- it’s OS, equipment and applications.

Developers answer- to enable a system through which the users can interact with other.
Designers will do the design of the application, interface. Sales, look at prospect and turn them
into orders, Supply chain, Take orders and turn them into invoices, Finance, Take invoices and
turn them to cash.

Firstly let us discuss what is output and input (land, labor, capital, financial), output is
something produced by a firm, and an input is raw materials used to create an out put in media
industry could be ( newspaper, a microblog site, News, TV Programs, movies etc.

The inputs used in media production are:

1. Artist/ Staff- We can hire and fire these people when needed, if you want to cut on the cost
or increase the productivity etc.
2. Equipments- we can take it for rent, or have own, like camera, visual mixers, lights etc.
3. Recording Studio- We can again use own studio or have a rented one.
4. Set (indoor/ outdoor) – depending on the need we can decide where to shoot.

We need to identify the fixed cost and variable costs. Fixed costs “cost of an input that does not
change when the level of output changes”. Eg: a recording studio owned the company,

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equipments owned. Variable costs” cost of an input that changes as level of output changes”
Staff, Duration of a Recorded Program, Visual Effects to be used etc.

Quantity of
Output
(cookies
per hour)
150 Production function
140
130
120
110
100
90
80
70
60
50
40 Number of Workers
30 Hired
20
10
0 1 2 3 4 5

Example above:

No of workers Cookies produced

1 50
2 90
3 120
5 150

Production function will work best if the company is a short-run. A short run “Period of time over
which some of the firm’s commitments and most are variable and can be changed with production
needs.” In a media industry, a short run firm has a advantage not want to build a studio that could

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produce more movies than it was ever likely to sell. By outsourcing, the firm can increase
production quickly if the product becomes popular they can think about setting up a studio and
things like that.

A production function looks at every possible combination of factors, assuming the most
efficient available methods of production are used. It could the measure the marginal
productivity of a particular factor of production and determine the cheapest combination of
production. “The marginal product of any input in the production process is the increase in the
quantity of output obtained from an additional unit of that input”. Example: when a media
company owner finds that the effort to create two distinct sets of copy for advertising is
counterproductive and does not result in enough additional sales to justify the effort.

When all other things remaining constant, and if only one input is increased a point will be
reached where each additional input produces less output than the previous input this is called
diminishing return. E.g.: New media staff has been hired, each additional worker contribute
less and less to production because it has limited amount of camera, lights, and other
equipment required for media production.

“Diminishing returns always apply in the short run, and in the short run every firm will face
diminishing returns. This means that every firm finds it progressively more difficult to increase
its output as it approaches capacity production”.

A total cost-curve shows the relationship between the quantity a firm can produce and its costs
determines pricing decisions. When the recording studio is crowded, each crew member add
less to production, reflecting diminishing marginal product. Here is the production function is
at fault. Also when the recording studio is crowded, producing an additional output requires a
lot of addition crew members and thus very costly. When the quantity, the no of crew members
are increased the total-cost curve will be steep.

When the marginal product declines, the production function becomes flatter. This is known as
Diminishing Marginal Product. Example: it is usually possible to increase the output of a
farm by adding more labor, fertilizers, or water-but only up to a certain extent. After that
the production graph will become flatter.

Production Function and Total cost Curve

The total cost curve graphically represents the relation between total cost and the quantity of
production.

b) Total Cost and Total Revenue

Total Cost is the amount a firm receives from the sale of its output.

A firm’s cost of production includes all the opportunity costs of making its output of goods
and services.

Costs: Explicit vs. Implicit:

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 Explicit costs; direct money spend for factors of production, eg paying wages to media
workers, rent paid to the apartment, equipments used for media production etc.
Implicit costs; do not require a cash outlay; these are intangible costs that are not easily
accounted for. E.g. the time and effort that an owner puts into the maintenance of the
company rather than working on expansion.

Let us look an example now for both costs and how it is calculated.

You need $100,000 to start your business.

The interest rate is 5%.
• Case 1: borrow $100,000
Explicit cost = $5000 interest on loan
• Case 2: use $40,000 of your savings,
Borrow the other $60,000
Explicit cost = $3000 (5%) interest on the loan
Implicit cost = $2000 (5%) foregone interest you could have earned on your $40,000.

Economic Profit versus Accounting Profit:

Accounting profit = total revenue minus total explicit costs

Economic profit = total revenue minus total costs (including explicit and implicit costs)
Accounting profit ignores implicit costs, so it’s higher than economic profit.

When total revenue exceeds both explicit and implicit costs, the firm earns economic
profit. Economic profit is smaller than accounting profit.

c) Different type of costs incurred by a typical firm.

In a typical scenario a media firm has many different costs, from paying for Equipments
through to the paying the rent or the Electricity bill. But we need to be careful on how to
classify these costs as a business can analyze its performance and make better-informed
decisions.

We can classify the costs in to two types a) Fixed and Variable b) Direct and Indirect Costs

Fixed costs are those costs that do not vary with the quantity of output produced. Examples of
fixed costs are: Rent, Salaries of Media activists, Electricity, Insurance etc.
Variable costs are those costs that do change as the firm alters the quantity of output produced
e.g.: Raw Materials, Workers Wages, Energy/ fuel for machines.

Direct Costs: costs that can be identified directly with the production of raw materials. Indirect
costs: costs which cannot be matched against each product because they need to be paid
whether production of good/services takes place. E.g.: Rent on the premises, you have to make

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payment whether the product has started or not. If you are able to identify the costs to the right
parts of P&L account, the breakeven point for the business can easily identified.

Total Fixed Costs: The sum of all costs required to produce the first unit of a product. This
amount does not vary as production increases or decreases, until new capital expenditures are
needed. Total Variable costs : t depends on the quantity of output produced and is equal to zero
when no output is produced variable costs are those costs which vary with the output level
produced, such as workers’ wages, material inputs, etc

Tot Total costs= Total Fixed Costs + Total Variable Costs

Quantity Total Cost Fixed Cost Variable Cost

0 $ 3.00 $3.00 $ 0.00
1 3.30 3.00 0.30
2 3.80 3.00 0.80
3 4.50 3.00 1.50
4 5.40 3.00 2.40
5 6.50 3.00 3.50
6 7.80 3.00 4.80
7 9.30 3.00 6.30
8 11.00 3.00 8.00
9 12.90 3.00 9.90
10 15.00 3.00 12.00

Average Costs: The average cost is the total cost divided by the number of units. Thus, if a firm
produces 10,000 units of output for a total cost of $25,000, the average cost of each unit is
$25,000
/10,000 units, or $2.50 per

Average Fixed Costs (AFC)- Average fixed cost is the total fixed cost per unit of output
incurred when a firm engages in short-run production , AFC can be calculated by dividing fixed
cost/ quantity (FC/Q).

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Average Variable Costs (AVC)
Average Total Costs (ATC)
ATC = AFC + AVC

Marignial Costs

Sunk Costs

III) Explain the ranges of elasticity. State the relationship between total revenue and
elasticity. How far is elasticity helpful in business decisions?

Elasticity is a “measure of how much buyers and sellers respond to changes in market
conditions”. The price elasticity of demand is commonly divided into three elasticity
alternatives--perfectly elastic, unit elastic, and perfectly inelastic--depending on the relative
response of quantity to price.

Determinants of Price elasticity of demand

1. Availability of close substitutes: the larger the number of close substitutes for the good then
the easier the household can shift to alternative goods if the price increases. Choosing between
two different detergent powders because of price increase.

Necessities vs. Luxury: If the good is a necessity item then the demand is unlikely to change for
a given change in price.

Definition of market: Consumers being more aware of small changes in price of expensive
goods compared to small changes in the price of inexpensive goods.

Time Horizon:

Perfectly elastic – “Quantity demanded changes infinitely with any change in price.” Perfectly
elastic demand can occur, in theory, when buyers have the choice among a large number of
perfect substitutes in the consumption of a good, also when sellers have the choice among a
large number of perfect substitutes in the production.

Perfectly elastic curve

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If the price should change by an infinitesimally small amount, then quantity explodes to an
infinitely large amount or drops to zero here. Demand is very very close (substitutes –in-
consumption) readily available. Example paper clips produced by Quad company.
Supply, imperfect substitutes readily available, any quantity of good can be produced, as there
is no increase in production cost and price, and be altered between goods.
Eg: The production cost of combining labor, kitchen utensils, mayonnaise, cheese, and bread
are one dollar per sandwich. This cost is the same for one sandwich or one billion sandwiches.

Perfectly Inelastic: “Quantity demanded does not respond to price changes”. The quantity is
essentially fixed. It does not matter how much price changes, quantity does not change.
Buyers have no choice in consumption of a good, sellers have no choice in production of a
good.

Unit Elastic: “Quantity demanded changes by the same percentage as the price”.
The percentage change in quantity is equal to the percentage change in price. For
example, a 22 percent change in price induces a equal 22 percent change in quantity
demanded. Buyers chose from among a modest number of substitutes in the consumption
of goods, suppliers choose among modest number of substitutes in production.
Consider a firm facing a downward sloping demand curve. The totalrevenue the firm
receives is the price of the good multiplied by thequantity sold. That is:

Total revenue = Price × Quantity Sold

The price elasticity of demand tells us what happens to total revenue when prices: its
size determines which effect – the price effect or the quantity effect – is stronger.
When the price increases, the unit sold sells for a higher price, which tends to raise
the revenue and whenthe fewer units are sold the revenue will be reduced

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Total Revenue and elasticity

Total revenue is the amount paid by buyers and received by sellers of a good.

an elastic demand curve, an increase in the price leads to a decrease in quantity

demanded that is proportionately larger. Thus, total revenue decreases.
Inelastic Demand: an increase in price leads to a decrease in quantity that is
proportionately smaller and TR increases. Elastic Demand : when an increase in the price
leads to a decrease in quan Income elasticity of demand measures how much the
quantity demanded of a good responds to a change in consumers’ income.

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IV) Define the term ‘returns to scale’. Explain the different stages of returns that a firm
goes through. Mention the significance of economies and diseconomies of scale in relation
to this.

“It is a situation in which we study the behavior of output when all the factors are varied in the
same proportion. It is applicable in the long run.”

There are 3 aspects of returns to scale

a) Increasing returns to scale – occurs when a given percentage increase in all factor
inputs in the same ratio causes proportionately greater increase in output

Scale of production Output

1 Machine + 2 Laboures 4 Chocolates

2 machine + 4 Laboures 8 Chocolates

2 Constant returns to scale :- Under this percentage increase in all factor inputs
in the same proportion causes equal percentage increase an output

Scale of production Output

1 Machine + 2 Laboures 1 Chocolate

2 machine + 4 Laboures 2 Chocolates

3 Diminishing returns to scale :- When a percentage increase in all factor inputs

in the same ratio causes proportionately lesser increase in output is known as
diminishing returns to scale

Scale of production Output

1 Machine + 2 Laborers 1 Chocolate

2 machine + 4 Laborers 1.5 Chocolate

Returns to scale are concerned with changes in the level of output as a result of changes in
the amount of factor inputs used.

Economies of scale are concerned with changes in cost per unit of output. Eg:. If doubling
output can be achieved with total cost less than doubling, you can achieve economies of
scale. If doubling output can only be achieved with total costs more than doubling, you are
faced with diseconomies of scale.

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Economies of scale in production mean that production at a larger scale (more output) can
be achieved at a lower cost. This is common in industries with large fixed costs, with huge
equipments and larger production unit. Here the cost of the equipment will be paid zero
even with no output. The more output the more the cost of this equipment can be spread
among more units of good. This is common in highly capital intensive industries such as
pharmaceuticals, chemical, petroleum and Automobiles etc. This is also because here the
average costs decline as the outputs are increased, it is cheaper to produce the average unit
as more units are produced, and economies of scale.

Increasing returns to scale in production means that an increase in resource usage, y% will
result in an increase in output by more than y%. when you increase the labor in an
aluminum plant , the aluminum production will be increased more. One of the advantage is
that economic of scale can generate trade gains because reallocation of resources can raise
productivity and it efficiency,

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