Case Study: Minimum Efficient Scale, Tariffs of Automobile Industries

Topics: Economics, Economics of production, Short-run Pages: 5 (1204 words) Published: April 29, 2012
Box4.4 Case Studies and Applications p111-112
Minimum efficient scale
1) Why might a firm operating with one plant achieve MEPS and yet not be large enough to achieve MES?

A firm that operates with one plant may only achieve minimum efficient plant size (MEPS) instead of minimum efficient scale (MES) in accordance to the size of the firm. This can be reasoned that the individual plant is not large enough comparing to a firm that operates with several plants. An individual factory can be categorized as a Short-run production, since it is only one factory, expanding the factory or building more factories will be considered as Long-run. Thus, the individual factory (one plant) of the firm is a fixed factor and the inputs are variable factors. The only way to expand firm production is to increase the outputs by increasing variable factors such as materials and labour. This process will lead to a similar theory of “economies of scale” consumption in the short-run period. MES will be relatively larger than MEPS in terms of production of outputs through this process. The example below will show why one plant cannot achieve MES, but instead only MEPS.

Take the case of an Orange juice production firm with a single factory: The Variable factors include the number of workers and oranges (input), and the fixed factor is the factory itself. In order to increase output, the firm needs to increase the number of workers and oranges. The “economies of scale” will occur when oranges from farms charges the firm a cheaper price (or discount) when the firm demands more oranges and when workers become more familiar with the environment and machines in the factory. However, since the factory has limited amount of workers and oranges it can hold, it will lead to the law of diminishing returns as it cannot produce more and more output. (When the SRAC curve rises it does not indicate the law of diminishing returns.)

According to Principles of Economics pg111, “The MES can be expressed in terms either of an individual factory or of the whole firm. Where it refers to the minimum efficient scale of an individual factory, the MES is known as the minimum efficient plant size (MEPS).” Hence, if MEPS applies to the individual Orange juice factory we can assume MEPS lies on the SRAC curve where it flattens off (end of economies of scale) as outlined below on Diagram 1:

If the orange juice production firm wants to expand its production to a higher degree as the individual factory cannot hold any more workers and oranges, it will need to build more factories which leads to the Long-run production scale. When each new factory is produced it is likely for the firm to experience economies of scale, thus new lower SRAC curves (SRAC1, SRAC2 and SRAC3) for every new factory as indicated on Diagram 2 ( There is a possibility for the firm to undergo diseconomies of scale at a certain point on the long-run. i.e. SRAC4.). Each factory itself will achieve MEPS as well individually.

As outlined before, MEPS will be achieved for individual plants in short-run production and provided that many SRAC curves make up a LRAC curve, the LRAC curve can be constructed by an envelope curve as it touches the tangent points of the SRAC curves. When the LRAC curve is constructed, we are able to specify where the MES point lies on the curve as shown on Diagram 3:

Through the discussion, we can conclude that MES will be achieved in firms with several factories in the long-run with a large production scale; however in an individual factory of a firm it can only achieve MEPS and not large enough to achieve MES due to its assumption category in the short-run.

Furthermore, if the plant can cover the whole output of the industry it may still not reach MES, since it covers all production (monopoly) there is no competition and thus the firm charges customers a high price. MEPS will be achieved through the...
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