2. Get help from fellow
students, teachers and
tutor2u on Twitter:
#econ3
@tutor2u_econ
3. Buying
economies
Buying in greater quantities usually results in a lower price (bulk-
buying) – the use of monopsony power
Technical Use of specialist equipment / bulky units of capital or specialist
processes to boost productivity e.g. law of increased dimensions
Risk-bearing Grow a wider range of products and customer markets through
diversification to lower market risk for investors
Marketing Spreading a fixed marketing spend over a larger range of products,
markets and customers
Network Adding extra customers or users to a network that is already
established (e.g. mobile phones)
Financial Larger firms benefit from access to cheaper finance, smaller businesses
often credit constrained
Industry An external economy – all competitors benefit – e.g. specialist
businesses grouped close together
Internal Economies of Scale
6. Long Run Cost Per Unit
Output
Cost
per unit
SRAC1
SRAC2
SRAC3 SRAC4
Internal economies of scale – falling unit costs as the scale of production grows
7. Long Run Cost Per Unit
Output
Cost
per unit
SRAC1
SRAC2
Economies of
scale
(increasing
returns)
Internal economies of scale – falling unit costs as the scale of production grows
8. Long Run Cost Per Unit
Output
Cost
per unit
SRAC1
SRAC2
Economies of
scale
(increasing
returns)
SRAC3
Constant
returns to scale
Internal economies of scale – falling unit costs as the scale of production grows
9. Long Run Cost Per Unit
Output
Cost
per unit
SRAC1
SRAC2
Economies of
scale
(increasing
returns)
SRAC3 SRAC4
Constant
returns to scale
Internal economies of scale – falling unit costs as the scale of production grows
10. Long Run Cost Per Unit
Output
Cost
per unit
SRAC1
SRAC2
Economies of
scale
(increasing
returns)
SRAC3 SRAC4
Constant
returns to scale
Diseconomies
of scale
LRAC
Internal economies of scale – falling unit costs as the scale of production grows
11. Minimum Efficient Scale (MES)
Output
Cost
per unit
LRAC
Economies of
scale
(increasing
returns)
Constant
returns to scale
Diseconomies
of scale
The minimum efficient scale is the scale of output where
internal economies of scale have been fully exploited
12. Cost & Price
Output (Q)
Different Shapes of Long Run Average Cost Curves
Low MES, limited scale
economies, contestable market
LRAC
Q1
Minimum
efficient
scale (MES)
Scope for many firms to
reach the MES
13. Cost & Price
Output (Q)
Different Shapes of Long Run Average Cost Curves
Low MES, limited scale
economies, contestable market
LRAC
Q1 Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
Natural Monopoly
Minimum
efficient
scale (MES)
Scope for many firms to
reach the MES
Q1 Q2 Q3 Q4
14. Falling LRAC for a natural monopoly
Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
Natural Monopoly
Q1 Q2 Q3 Q4
London Underground
Water & Sewerage
Networks
15. Falling LRAC for a natural monopoly
Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
Natural Monopoly
Q1 Q2 Q3 Q4
London Underground
Water & Sewerage
Networks
16. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
In this example, increasing the
scale of production allows a
move from AC1 to AC2
17. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
Add in the revenue curve (AR)
18. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
And the marginal revenue (MR)
19. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Profit maximising output is at
Q1 and the optimum price is P1
20. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
With economies of scale, the
profit maximising price and
output changes to P2, Q2
21. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Profit at
price P1
22. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Profit at
price P1
Profit at
price P2
23. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
What are the effects of this for
consumer welfare?
24. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Consumer surplus increases
because of the higher output
and lower price
25. Output (Q)
Cost & Price
Economies of Scale – Prices, Profit and Welfare
AC2MC2
AR
MR
Q2
P2
Consumer surplus at P2
26. Falling LRAC for a natural monopoly
Output (Q)
Natural Monopoly
Cost & Price
LRAC
27. Falling LRAC for a natural monopoly
Output (Q)
LRMC
Natural Monopoly
Cost & Price
LRAC
With a natural monopoly,
the long run average cost
curve continues to fall
over a huge range of
output
28. Falling LRAC for a natural monopoly
Output (Q)
LRMC
Natural Monopoly
Cost & Price
LRAC
AR
MR
With a natural monopoly,
the long run average cost
curve continues to fall
over a huge range of
output
29. Falling LRAC for a natural monopoly
Output (Q)
LRMC
Profit maximising output is lower than the minimum
efficient scale
Cost & Price
LRAC
AR
MR
Q1
P1
30. Falling LRAC for a natural monopoly
Output (Q)
LRMC
Profit maximising output is lower than the minimum
efficient scale
Cost & Price
LRAC
AR
MR
Q1
P1
C1
31. Falling LRAC for a natural monopoly
Output (Q)
LRMC
Total profit at Q1
Cost & Price
LRAC
AR
MR
Q1
P1
C1
32. Cost & Price
Output (Q)
Long Run Cost Advantages for Existing / Established Businesses
Cost advantage for Firm A over
a potential rival Firm B
At output Q1 – firm A has a big
cost advantage over a
potential rival firm B
Reasons?
Firm B
Firm A
Q1
AC (B)
AC (A)
33. Cost & Price
Output (Q)
Long Run Cost Advantages for Existing / Established Businesses
Cost advantage for Firm A over
a potential rival Firm B
At output Q1 – firm A has a big
cost advantage over a
potential rival firm B
1. Learning economies
2. Vertical integration
3. Lower customer churn
4. Monopsony power
Firm B
Firm A
Q1
AC (B)
AC (A)
35. External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an
industry – they arise from the growth of an industry
Science Parks – University
Research
Agglomeration Economies
– knowledge clusters
36. External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an
industry – they arise from the growth of an industry
Science Parks – University
Research
Agglomeration Economies
– knowledge clusters
41. External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an
industry – they arise from the growth of an industry
Output
LRAC1
B
Internal Economies of Scale
A
Cost
(per unit
of output)
42. External Economies of Scale (EEoS)
External economies of scale occur outside of a firm but within an
industry – they arise from the growth of an industry
Output
LRAC1
B
Internal Economies of Scale
A
Cost
(per unit
of output)
LRAC2 (EEoS)
External
Economies of
Scale
43. Economies of Scope
Where it is cheaper to produce a range of products rather than
specialize in a very limited number
44. Economies of Scope
Where it is cheaper to produce a range of products rather than
specialize in a very limited number
Hypermarkets Amazon Proctor & Gamble
45. Economies of Scope
Where it is cheaper to produce a range of products rather than
specialize in a very limited number
Hypermarkets Amazon Proctor & Gamble
46. Economies of Scope
Where it is cheaper to produce a range of products rather than
specialize in a very limited number
Hypermarkets Amazon Proctor & Gamble
47. Amazon and Economies of Scope
Amazon launched its
groceries range,
which includes tea,
pasta and biscuits, in
July 2010 with little
more than 22,000
products. However, it
now offers in excess
of 150,000 products,
from crisps to
nappies, which are
typically sold in bulk,
as it attempts to
gobble up sales from
the high street
48. Poor communication within businesses
More difficult to control a larger, more complex business
More frequent machinery & employee breakdown if output &
capacity utilisation is too high
Loss of management focus, greater risk of industrial relations
problems and possible strikes
Factors which cause the average production cost per unit of a business to
increase above the efficient level…for example
Internal Diseconomies of Scale – Rising LRAC
49. Get help from fellow
students, teachers and
tutor2u on Twitter:
#econ3
@tutor2u_econ