Chapter 1 Notes

Explain why MES is likely to vary between different industries.

Minimum efficient scale (MES) is defined by the lowest point on the long-run average total cost curve and is also known as the output of long-run productive efficiency. Economies of scale can be defined as lower unit costs of production that arises with increased output of a product. MES varies between different industrials because different industries have different economies of scale. This can arise from different fixed unit costs. For example, National Rail has very high fixed costs due to the need to build railroad infrastructure, meaning that there are large economies of scale due to high fixed costs being spread over a larger number of units. Or cigarettes! On the other hand, a window cleaning firm may have low fixed costs (only need buckets!) while high variable costs (costs of labour) small economies of scale low MES. Could also be low MES due to diseconomies of scale e.g. workers in window cleaning firm may feel alienated not feel an integral part of business productivity falls wastage of factor inputs and higher costs.

Evaluate what a firm could do if demand for its product increases.

Define LR/SR All factors of production can be adjusted, while in SR 1+ factors cant be changed. In SR firms produce more to meet growing demand by employing more factors of production SRATC could rise less profit could even lead to subnormal profits opportunity cost is too great no incentive to produce more (assume perfect competition) In the LR firm could for example invest in more capital equipment LRATC shifts right firm can now meet demand at new price higher profits Will they necessarily invest in capital? Is increase in demand short run/long run? e.g. demand for Christmas wrapping paper in December extra capital is wasted. Also firms need to fund capital investment small firms dont want this option or dont want to pay high interest on loans.

Evaluation: Do economies of scale always improve the welfare of consumers?

Define economies of scale. Industries with EoS (e.g. car industry) have high fixed costs due to costs of capital as fixed costs are spread over more units lower SRATC savings passed onto consumers in perfect competition larger output at lower price improvement in efficiency and surplus consumer welfare. Does it depend on industry? Diseconomies of scale may appear e.g. workers in window cleaning firm may feel alienated not feel an integral part of business productivity falls wastage of factor inputs and higher costs less consumer surplus and welfare. Are savings passed onto consumers necessarily? If monopoly e.g. BT may lead to higher prices (diagram) loss of consumer welfare and allocative efficiency? OTOH, extra profits may be used in more investment higher quality products eventually leads to higher consumer welfare. But will there be an incentive for higher quality products if monopoly? One can also argue that mass production standardisation of products limits consumer choice (e.g. Fords assembly line meant all cars were painted black).

Assess the view diminishing returns can always be eliminated by a firm by increasing its levels of output.
Define diminishing marginal returns. Look at SR vs LR (define and explain SR) In SR if increased demand higher output higher variable costs e.g. more labour while maintaining other factors of production SR diminishing returns not eliminated e.g. initially food output on a farm rises more than proportionally only a certain no. workers can work on farm before capacity of farmland approached falling farmlandNOTE: with assumption of decreased costs. On the other hand, in LR all factors movable e.g. can increase farmland SRATC shifts along LRATC envelope increased output and lower ATC. Lower ATC possibly due to 1

economies of scale derived from large fixed costs being spread over more units (e.g. National Rail has large fixed costs of rail infrastructure). Will firms want to increase factors in production in LR? Costly for firms if demand increase is short term excess capacity Also, CAN they increase factors of production in LR? Financial constraints e.g. in a credit crunch banks are less willing to lend investment may be derived solely from firm profits profits may be insufficient? Depends on type of industry e.g. in construction planning permission needed may be unable to expand building especially in areas like Green Belt. Many also depend on SIZE of firm relative to industry if too large market share fears of monopoly expansion may be prohibited by Competition Commission. BY increasing output in LR, could it lead to diseconomies of scale e,g, window cleaning firm employers in large firm dont feel an integral part less motivated productivity falls decreasing returns to scale. Are firms producing at the minimum point on the SRATC? e.g. if demand increases after a recession, then firm is initially producing under capacity same fixed costs spread over more output economies of scale increasing returns of scale rather than diminishing Also, concept of natural monopolies very large MES Conclusion: depends on TYPE of industry, SIZE of firm RELATIVE to industry and where the firm is at initially. Seems sometimes, but not always. Possible more likely in current UK economic climate with recovery

Evaluate the view that Firms in the same industry have very similar average costs of production
Define ATC (formula). Assume cost curves are similar due to facing the same fixed/variable costs e.g. they buy same raw materials, need the same capital, similar workers. Is this true? Fixed/variable costs change according to country e.g. labour is cheaper in China than in UK, also cheaper fixed costs due to less costs of land etc. Even inside a country different wages (north/south divide). But can also argue that globalisation manufacturing moved to China (e.g. steel production) firms end up all with similar costs again in long term. Also, larger firms more monopsony power can negotiate lower costs from suppliers e.g. Tesco can negotiate lower milk pricesdifferent AVC than a newsagents. Can also carry out negotiations in the futures market? the internal structure of companies may be different: e.g. company with no incentive pay workers have lower morale less productivity higher average costs This assumes different firms sizes though? Where there is perfect competition similar goods produced initially firms have different cost curves more efficient firms with lower costs lower prices less efficient firms make subnormal profits leave industry eventually only firms that reach MES remain in industry firms produce similar outputs. Of course, perfect competition assumes product homogeneity; depends on industry: e.g. in chocolate industry, product differentiation between boutique chocolates and Cadburys mass production different fixed and variable costs. Conclusion: seems unlikely to be VERY similar in some industries, but more likely in others.