Cost concepts:

The burden sustained in order to perform a certain activity, to carry out a certain
production, to achieve certain goals.

differences between short and long run costs:

In the short run, there are both fixed and variable costs.
In the long run, there are no fixed costs.
Efficient long run costs are sustained when the combination of outputs that a firm
produces results in the desired quantity of the goods at the lowest possible cost.
Variable costs change with the output. Examples of variable costs include employee
wages and costs of raw materials.
The short run costs increase or decrease based on variable cost as well as the rate
of production. If a firm manages its short run costs well over time, it will be more
likely to succeed in reaching the desired long run costs and goals.

variable cost
A cost that changes with the change in volume of activity of an organization.
fixed cost
Business expenses that are not dependent on the level of goods or services
produced by the business.
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In economics, "short run" and "long run" are not broadly defined as a rest of time.
Rather, they are unique to each firm.
Long Run Costs

Long run costs are accumulated when firms change production levels over time in
response to expected economic profits or losses. In the long run there are no
fixedfactors of production. The land, labor, capital goods, and entrepreneurship all
vary to reach the the long run cost of producing a good or service. The long run is a
planning and implementation stage for producers. They analyze the current and
projected state of the market in order to make production decisions. Efficient long
run costs are sustained when the combination of outputs that a firm produces
results in the desired quantity of the goods at the lowest possible cost. Examples of
long run decisions that impact a firm's costs include changing the quantity of
production, decreasing or expanding a company, and entering or leaving a market.
Short Run Costs
Short run costs are accumulated in real time throughout the production
process. Fixed costs have no impact of short run costs,
only variable costs and revenues affect the short run production. Variable costs
change with the output. Examples of variable costs include employee wages and
costs of raw materials. The short run costs increase or decrease based on variable
cost as well as the rate of production. If a firm manages its short run costs well over
time, it will be more likely to succeed in reaching the desired long run costs and
goals.
Differences
The main difference between long run and short run costs is that there are no fixed
factors in the long run; there are both fixed and variable factors in the short run . In
the long run the general price level, contractual wages, and expectations adjust
fully to the state of the economy. In the short run these variables do not always
adjust due to the condensed time period. In order to be successful a firm must set
realistic long run cost expectations. How the short run costs are handled determines
whether the firm will meet its future production and financial goals.
Source: Boundless. Short Run and Long Run Costs. Boundless Economics.
Boundless, 15 Jul. 2015. Retrieved 17 Jul. 2015
from https://www.boundless.com/economics/textbooks/boundless-economicstextbook/production-9/production-cost-64/short-run-and-long-run-costs-242-12340/

Long run costs are accumulated when firms change /The long run average cost
curve is derived from a series of short run average cost curves and so is often
described as the envelope curve.

If a firm is producing in the most efficient

way possible in the long run, but they
then want to expand, they will have to
expand along a short run average cost
curve as they will be limited by their fixed
factors. However, in the long run they can
get more of the fixed factors and so will
move back down to the long run average
cost curve. This is why the LRAC is made
up of a series of SRAC curves.

Economy of scale
When more units of a good or a service can be produced on a larger scale, yet with
(on average) less input costs, economies of scale (ES) are said to be achieved.
Alternatively, this means that as a company grows and production units increase, a
company will have a better chance to decrease its costs. According to theory,
economic growth may be achieved when economies of scale are realized.
Adam Smith identified the division of labor and specialization as the two key means
to achieve a larger return on production. Through these two techniques, employees
would not only be able to concentrate on a specific task, but with time, improve the
skills necessary to perform their jobs. The tasks could then be performed better and
faster. Hence, through such efficiency, time and money could be saved while
production levels increases..
Internal and External Economies of Scale
Alfred Marshall made a distinction between internal and external economies of
scale. When a company reduces costs and increases production, internal economies
of scale have been achieved. External economies of scale occur outside of a firm,
within an industry. Thus, when an industry's scope of operations expands due to, for
example, the creation of a better transportation network, resulting in a subsequent
decrease in cost for a company working within that industry, external economies of
scale are said to have been achieved. With external ES, all firms within the industry
will benefit.

Where Are Economies of Scale?

In addition to specialization and the division of labor, within any company there are
various inputs that may result in the production of a good and/or service.
Lower input costs: When a company buys inputs in bulk - for example, potatoes
used to make French fries at a fast food chain - it can take advantage of volume

discounts. (In turn, the farmer who sold the potatoes could also be achieving ES if
the farm has lowered its average input costs through, for example, buying fertilizer
in bulk at a volume discount.)
Costly inputs: Some inputs, such as research and development, advertising,
managerial expertise and skilled labor are expensive, but because of the possibility
of increased efficiency with such inputs, they can lead to a decrease in the average
cost of production and selling. If a company is able to spread the cost of such inputs
over an increase in its production units, ES can be realized. Thus, if the fast food
chain chooses to spend more money on technology to eventually increase efficiency
by lowering the average cost of hamburger assembly, it would also have to increase
the number of hamburgers it produces a year in order to cover the increased
technology expenditure.
Specialized inputs: As the scale of production of a company increases, a company
can employ the use of specialized labor and machinery resulting in greater
efficiency. This is because workers would be better qualified for a specific job - for
example, someone who only makes French fries - and would no longer be spending
extra time learning to do work not within their specialization (making hamburgers or
taking a customer's order). Machinery, such as a dedicated French fry maker, would
also have a longer life as it would not have to be over and/or improperly used.
Techniques and Organizational inputs: With a larger scale of production, a company
may also apply better organizational skills to its resources, such as a clear-cut chain
of command, while improving its techniques for production and distribution. Thus,
behind the counter employees at the fast food chain may be organized according to
those taking in-house orders and those dedicated to drive-thru customers.
Learning inputs: Similar to improved organization and technique, with time, the
learning processes related to production, selling and distribution can result in
improved efficiency - practice makes perfect!
External economies of scale can also be realized from the above-mentioned inputs
as a result of the company's geographical location. Thus all fast food chains located
in the same area of a certain city could benefit from lower transportation costs and
a skilled labor force. Moreover, support industries may then begin to develop, such
as dedicated fast food potato and/or cattle breeding farms.
External economies of scale can also be reaped if the industry lessens the burdens
of costly inputs, by sharing technology or managerial expertise, for example. This
spillover effect can lead to the creation of standards within an industry

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Economies of scale
Economies of scale are factors that cause the average cost of producing something
to fall as the volume of its output increases. Hence it might cost $3,000 to produce
100 copies of a magazine but only $4,000 to produce 1,000 copies. The average
cost in this case has fallen from $30 to $4 a copy because the main elements of
cost in producing a magazine (editorial and design) are unrelated to the number of
magazines produced.

Economies of scale were the main drivers of corporate gigantism in the 20th
century. They were fundamental to Henry Ford's revolutionary assembly line, and
they continue to be the spur to many mergers and acquisitions today.
There are two types of economies of scale:
Internal. These are cost savings that accrue to a firm regardless of the industry,
market or environment in which it operates.
External. These are economies that benefit a firm because of the way in which its
industry is organised.
Internal economies of scale arise in a number of areas. For example, it is easier for
large firms to carry the overheads of sophisticated research and development
(R&D). In the pharmaceuticals industry R&D is crucial. Yet the cost of discovering
the next blockbuster drug is enormous and increasing. Several of the mergers
between pharmaceuticals companies in recent years have been driven by the
companies' desire to spread their R&D expenditure across a greater volume of
sales.
Economies of scope
First cousins to economies of scale are economies of scope, factors that make it
cheaper to produce a range of products together than to produce each one of them
on its own. Such economies can come from businesses sharing centralised
functions, such as finance or marketing. Or they can come from interrelationships
elsewhere in the business process, such as cross-selling one product alongside
another, or using the outputs of one business as the inputs of another.

Just as the theory of economies of scale has been the underpinning for all sorts of
corporate behaviour, from mass production to mergers and acquisitions, so the idea
of economies of scope has been the underpinning for other sorts of corporate
behaviour, particularly diversification.

The desire to garner economies of scope was the driving force behind the vast
international conglomerates built up in the 1970s and 1980s, including BTR and
Hanson in the UK and ITT in the United States. The logic behind these
amalgamations lay mostly in the scope for the companies to leverage their financial
skills across a diversified range of industries.
A number of conglomerates put together in the 1990s relied on cross-selling, thus
reaping economies of scope by using the same people and systems to market many
different products. The combination of Travelers Group and Citicorp in 1998, for
instance, was based on the logic of selling the financial products of the one by using
the sales teams of the other
Economies of scope are cost advantages that result when firms provide a variety of
products rather than specializing in the production or delivery of a single product or
service. Economies of scope also exist if a firm can produce a given level of output
of each product line more cheaply than a combination of separate firms, each
producing a single product at the given output level. Economies of scope can arise
from the sharing or joint utilization of inputs and lead to reductions in unit costs.
Scope economies are frequently documented in the business literature and have
been found to exist in countries, electronic-based B2B (business-to-business)
providers, home healthcare, banking, publishing, distribution, and
telecommunications.
METHODS OF ACHIEVING ECONOMIES OF SCOPE
Flexible Manufacturing
The use of flexible processes and flexible manufacturing systems has resulted in
economies of scope because these systems allow quick, low-cost switching of one
product line to another. If a producer can manufacture multiple products with the
same equipment and if the equipment allows the flexibility to change as market
demands change, the manufacturer can add a variety of new products to their
current line. The scope of products increases, offering a barrier to entry for new
firms and a competitive synergy for the firm itself.
Related Diversification
Economies of scope often result from a related diversification strategy and may
even be termed "economies of diversification." This strategy is made operational
when a firm builds upon or extends existing capabilities, resources, or areas of
expertise for greater competitiveness. According to Hill, Ireland, and Hoskisson in
their best selling strategic management textbook, Strategic Management:
Competitiveness and Globalization, firms select related diversification as their
corporate-level strategy in an attempt to exploit economies of scope between their
various business units. Cost-savings result when a business transfers expertise in
one business to a new business. The businesses can share operational skills and

know-how in manufacturing or even share plant facilities, equipment, or other

existing assets. They may also share intangible assets like expertise or a corporate
core competence. Such sharing of activities is common and is a way to maximize
limited constraints.
As an example, Kleenex Corporation manufactures a number of paper products for a
variety of end users, including products targeted specifically for hospitals and health
care providers, infants, children, families, and women. Their brands include Kleenex,
Viva, Scott, and Cottonelle napkins, paper towels, and facial tissues; Depends and
Poise incontinence products; Huggies diapers and wipes; Pull-Ups, Goodnites, and
Little Swimmers infant products; Kotex, New Freedom, Litedays, and Security
feminine hygiene products; and a number of products for surgical use, infection
control, and patient care. All of these product lines utilize similar raw material inputs
and/or manufacturing processes as well as distribution and logistics channels.
Mergers
The merger wave that swept the United States in the late 1990s and early 2000s is,
in part, an attempt to create scope economies. Mergers may be undertaken for any
number of reasons. "As a rule of thumb," explained Rob Preston in an article about
the trouble with mergers, "'scope' acquisitionsmoves that enhance or extend a
vendor's product portfoliosucceed more often than those undertaken to increase
size and consolidate costs." Pharmaceutical companies, for example, frequently
combine forces to share research and development expenses and bring new
products to market. Research has shown that firms involved in drug discovery
realize economies of scope by sustaining diverse portfolios of research projects that
capture both internal and external knowledge spillovers.
Linked Supply Chains
Today's linked supply chains among raw material suppliers, other vendors,
manufacturers, wholesalers, distributors, retailers, and consumers often bring about
economies of scope. Integrating a vertical supply chain results in productivity gains,
waste reduction, and cost improvements. These improvements, which arise from
the ability to eliminate costs by operating two or more businesses under the same
corporate umbrella, exist whenever it is less costly for two or more businesses to
operate under centralized management than to function independently.
The opportunity to gain cost savings can arise from interrelationships anywhere
along a value chain. As firms become linked in supply chains, particularly as part of
the new information economy, there is a growing potential for economies of scope.
Scope economies can increase a firm's value and lead to increases in performance
and higher returns to shareholders. Building economies of scope can also help a
firm to reduce the risks inherent in producing a single product or providing a service
to a single industry.

Learning curve:
A learning curve is a graphical representation of the increase
of learning (vertical axis) with experience (horizontal axis).

In a visual representation of a learning curve, a steeper curve indicates faster,

easier learning and a flatter curve indicates slower, more difficult learning. The
concept of a learning curve is important to companies in hiring and training new
employees and managers, in working to increase production efficiency, and in
budgeting and forecasting costs.
According to it cumulative experience in the production of a product over time
increases efficiency in the use of inputs such as labour and raw materials and
thereby lowers cost per unit of output.
For example, if in a production process labour-input cost experiences 80 per cent
learning curve effect, this means that if in the first period production of a unit of
output requires labour cost of Rs. 1000, in the next period labour cost per unit will
decline to Rs. 800 and so forth.
It is important to note that reduction in cost per unit due to the learning curve effect
is different from economies of scale. Whereas economies of scale refer to the
decline in cost per unit of output as a firms output per time period increases, the
learning curve describes the reduction in cost per unit of output as a firms
cumulative output over successive time periods increases, while output per period
may remain the same.
This learning-curve relationship between cost outputs is expressed
algebraically as follows:

C = aAb

Where,

C is the input cost of Qth unit of output,

Q is successive unit of output produced,
a is the input cost per unit of output in the first period and
b is the rate of decline in cost per unit of output in the successive period.