Economies of scale
The long run – increases in scale
A firm’s efficiency is affected by its size. Large firms are often more efficient than small ones because they can gain from economies of scale, but firms can become too large and suffer from diseconomies of scale. As a firm expands its scale of operations, it is said to move into its long run. The benefits arising from expansion depend upon the effect of expansion on productive efficiency, which can be assessed by looking at changes in average costs at each stage of production. How does a firm expand?
A firm can increase its scale of operations in two ways.
Internal growth, also called organic growth
External growth, also called integration - by merging with other firms, or by acquiring other firms By growing, a firm can expect to reduce its average costs and become more competitive. Long run costs
The firm’s long run average cost shows what is happening to average cost when the firm expands, and is at a tangent to the series of short run average cost curves. Each short run average cost curve relates to a separate stage or phase of expansion.
The reductions in cost associated with expansion are called economies of scale. Internal and external economies and diseconomies of scale
External economies and diseconomies
External economies and diseconomies of scale are the benefits and costs associated with the expansion of a whole industry and result from external factors over which a single firm has little or no control. External economies of scale include the benefits of positive externalities enjoyed by firms as a result of the development of an industry or the whole economy. For example, as an industry develops in a particular region an infrastructure of transport of communications will develop, which all industry members can benefit from. Specialist suppliers may also enter the industry and existing firms may benefit from their proximity. External diseconomies are costs which are outside the...
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