Economies
What is Economies of Scale?
Economies of Scale refer to the cost advantage experienced by a firm when it increases its level of output. The greater the quantity of output produced, the lower the per-unit fixed cost.
The advantage arises due to the inverse relationship between per-unit fixed cost and the quantity produced. This is brought about by operational efficiencies and synergies as a result of an increase in the scale of production.
For example, the cost of producing one unit is less when many units are produced at once.
Effects of Economies of Scale on Production Costs
1. It reduces the per unit fixed cost. As a result of increased production, the fixed cost gets spread over more output than before.
2. It reduces the per unit variable costs. Economies of scale bring down the per unit variable costs. This occurs as the expanded scale of production increases the efficiency of the production process.
The graph above plots the long run average costs faced by a firm against its level of output. When the firm expands its output from Q to Q2, its average cost falls from C to C1. Thus, the firm can be said to experience economies of scale up to output level Q2. (In economies a key result that emerges from the analysis of the production process is that a profit-maximizing firm always produces that level of output which results in the least average cost per unit of output).
Types of Economies of Scale
1. Internal Economies of Scale
Internal economies are, as the name implies, internal to the company itself and controllable by management.
For instance, a firm may hold a patent over a mass production machine, which allows it to lower its average cost of production more than other firms in the industry.
2. External Economies of Scale
External economies are supported by external factors. These factors include the industry, geographic location, or government.
For instance, suppose the government wants to increase steel production. In order to do so, the government announces that all steel producers who employ more than 10,000 workers will be given a 20% tax break. Thus, firms employing less than 10,000 workers can potentially lower their average cost of production by employing more workers. This is an example of an external economy of scale – one that affects an entire industry or sector of the economy.
Sources of Economies of Scale
1. Purchasing
Firms might be able to lower average costs by buying the inputs required for the production process in bulk or from special wholesalers.
2. Managerial
Firms might be able to lower average costs by improving the management structure within the firm. The firm might hire better skilled or more experienced managers.
3. Technological
A technological advancement might drastically change the production process. For instance, franking completely changed the oil industry a few years ago. However, only large oil firms that could afford to invest in expensive franking equipment could take advantage of the new technology.
Difference Between Micro and Macro Economics
asis for Comparison
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Microeconomics
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Macroeconomics
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Meaning
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The branch of economics that studies the behavior of an individual consumer, firm, family is known as Microeconomics.
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The branch of economics that studies the behavior of the whole economy, (both national and international) is known as Macroeconomics.
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Deals with
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Individual economic variables
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Aggregate economic variables
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Business Application
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Applied to operational or internal issues
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Environment and external issues
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Scope
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Covers various issues like demand, supply, product pricing, factor pricing, production, consumption, economic welfare, etc.
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Covers various issues like, national income, general price level, distribution, employment, money etc.
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Importance
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Helpful in determining the prices of a product along with the prices of factors of production (land, labor, capital, entrepreneur etc.) within the economy.
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Maintains stability in the general price level and resolves the major problems of the economy like inflation, deflation, reflation, unemployment and poverty as a whole.
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Limitations
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It is based on unrealistic assumptions, i.e. In microeconomics it is assumed that there is a full employment in the society which is not at all possible.
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It has been analyzed that 'Fallacy of Composition' involves, which sometimes doesn't proves true because it is possible that what is true for aggregate may not be true for individuals too.
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Elastic Demand
Elasticity of demand is illustrated in Figure 1. Note that a change in price results in a large change in quantity demanded. An example of products with
an elastic demand is consumer durables. These are items that are purchased infrequently, like a washing machine or an automobile, and can be postponed if price rises. For example, automobile rebates have been very successful in increasing automobile sales by reducing price.
An example of computing elasticity of demand using
the formula above is shown below. When the price
decreases from $10 per unit to $8 per unit, the quantity sold increases from 30 units to 50 units.
Inelastic Demand
Inelastic demand is shown in Figure 2. Note that a change in price results in only a small change in quantity demanded. In other words, the quantity demanded is not very responsive to changes in price.
Examples of this are necessities like food and fuel.Consumers will not reduce their food purchases if food prices rise, although there may be shifts in the types of food they purchase. Also, consumers will not greatly change their driving behavior if gasoline
prices rise.
Unit elastic demand If the percentage change in the quantity demanded equals the percentage change in the price , then the price elasticity equals I
Example: If I give my to my brother $20 to buy candy, and if he spends the $20 on as much candy as he can get, no matter the price (i.e., he goes to the clerk in the store and says: please give me the amount of candy I can afford for $20), then his demand has unit elasticity: no matter the price, he will spend the $20. If the price goes up by 10%, he will just buy 10% fewer pieces of candy.
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