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Cost of Production (2)

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Miss Cummins

on 8 March 2017

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Transcript of Cost of Production (2)

Cost of Production (2)
SRAC/LR/Economies of Scale

THE LONG RUN
All factors are variable

Exact amount of each could be used to achieve maximum utility

No set time period - depends on situation


What determines the Shape of the LRAC Curve?
Generally saucer shaped

Firm grows in sizes ---> experiences cost savings which are called
economies of scale
Short Run Average Cost (SRAC) Curve
FROM A to B

Generally U-shaped

Slopes downwards

Why?

Not all firms benefit from Economies of Scale.
How do small firms survive if they don't?
Small size of the market - large scale may not survive - Small guesthouse versus large hotel
What effect do returns to scale have on costs?
1. Specialisation/division of labour
Increase in production and firm employs specialists
OR
Existing workers concentrate on a smaller number of tasks

This leads to:
Greater efficiency --> lowers unit costs
2. Greater spread of fixed costs
Company expands --> FC don't increase directly as more is produced

FC are static over time --> step-by-step

FC are spread out over increasing units which means that as production increases, the FC per unit will fall
Costs
Quantity
Downward sloping due to greater spread of FC
+
Specialisation of Labour
Upwards sloping due to law of diminishing marginal returns
SRAC
A
B
C
FC
Costs
Quantity
A
B
C
FROM B TO C THE SRAC SLOPS UPWARDS
Why?
The Law of Diminishing Marginal Returns
This means higher cost per unit ---> SRAC in slop upwards
It now takes more workers to produce a given quantity than it did when production first commenced
Produce more in the SR - increased variable factors (labour) per unit produced

Example on sheet!
LR average cost curve is made up of the minimum point of many SRAC curves, each representing a different factory size
Long run is a series of short run costs into the future
These savings cause the LRAC to slope downwards and average costs decrease
Upwards part is due to
diseconomies of scale
and average costs begin to increase
Costs
Quantity
C
Q
Economies of scale dominant/increasing returns to scale
Optimum level of output
Diseconomies of scale dominant/decreasing returns to scale
LRAC
Economies of Scale
result in the reduction in the LRAC of production as the firm/industry increases its size of operation
Diseconomies of Scale
result in an increase in the LRAC of production as the firm/industry increases its size of operation
Both economies of scale and diseconomies of scale are present at all levels of output

Minimum point on LRAC = optimum level of output --> best use of all resources

Economies dominant = slope downwards

Diseconomies dominant = slope upwards
SHEET!!
Returns to Scale
- changing all factors and the consequent effect on output

Sheet on Economies of Scale
Membership of voluntary groups - small companies joining up with similar produce - sole owner grocery shop
Nature of the good - heavy commodity may be made locally for ease of transport - concrete blocks
Traditional markets - small business can set up near a market - street hawkers
Personal services - small business may have a special/personal item desired by customers - Handcrafted jewellery
Consumer loyalty - small business may have a reputation and loyal customers which makes it difficult for new firms to enter
Benefits of Small-Scale Enterprise
Some business are suited to producing certain goods - economies of scale may not be important
Advantages of these enterprises?
Quick response time
Decision making
High Output per head
Fewer HR problem
Lower overheads
Full transcript