In the previous posts in this Demand and supply analysis series we have covered topics such as elasticity of demand and supply, consumer demand and what affects it, Fixed, marginal,total, average and variable costs. Today in the last post of this series we will look into economies of scale and diseconomies of scale and how they are achieved or caused in the short and long run.
In the long run all factors of production are variable including plant size. In the short run each plant size will have its short run average total cost curve (SRATC). The long run average total cost curve (LRATC) is made up of many short run total cost (SRATC) curves. The downward slope of the LRATC is the economies of scale achieved with various plant sizes. The plant size at which the economies of scale is greatest is the lowest point on the long run average total cost (LRATC) curve. This scale is called the minimum efficient scale. Economies of scale are achieved through mass production, lower raw material costs due to large size of the firms, etc. Beyond this point as the plant size goes on increasing it leads to diseconomies of scale. To survive and remain in the industry the firms have to then reduce their output and move back towards the minimum efficient scale plant size.
For a firm operating at plant size SRATC1, at market price P1, the firm would want to increase its size to SRATC2 in search of larger profits. If the market price remains at P1, the firm will earn positive economic profits. At the minimum efficient scale firms will be in equilibrium and have zero economic profits. As they increase their size beyond this point, supply will increase and cause the market price to move below P2 which will lead to economic losses causing some firms to shutdown and exit. The exit of some firms will again reduce the supply and cause the price to move back up to P2 and beyond.
As more and more firms enter an industry in search of profits, the cost of inputs increase as their demand increases. This leads to an increasing cost industry. The long run supply curve for such an industry is upward sloping as a result because as the output increases the costs also increase, and therefore the output has to be sold at higher and higher prices.
In some industries, expansion of the industry leads to decrease in prices of the raw materials due to economies of scale in production of raw materials. For example, the mobile phone industry. As the industry expanded the cost of raw materials needed to produce the mobile phones decreased significantly thus leading to a fall in the average cost of mobile phones. The long run supply curve of such an industry is therefore downward sloping as larger quantities become available at lower and lower prices.
For industries in which input costs do not increase or decrease with output, such industries are called constant cost industries.
That’s all in this post …..Thanks for reading….from the next post onwards we start a new topic series where we would read all about the different market structures …bye until then…
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