Syllabus requirements

1. Objectives profit maximisation (MC=MR) and ALTERNATIVES 2. COSTS short/long fixed/variable EOS 3. Range of competition market structures
Compare
Efficiency Equity Innovation Consumer choice

4. Barriers to entry 5. Behaviour of firms

Price discrimination Price and non-price competition Collusion and competition Interdependence (oligopoly)

Essay Question
Large firms enjoy lower costs thus they can charge lower prices. a) Explain why large firms may enjoy lower costs. [12] b) Discuss the view that large firms are beneficial in view of the cost-savings they enjoy [13]

a) Definition - context
I am going to offer some definitions and then use the idea of economies of scale to explain why some firms can enjoy lower costs

Introduction firm unit of production. INPUT PROCESS - OUTPUT Production important to understand supply. Supply important because its part of the market. Market is important because it is the MECHANISM for allocating scarce resources.

SUBSTANCE OF ANSWER b) Explain why large firms may enjoy lower costs.

COSTS PAYMENTS TO FACTORS OF

PRODUCTION

Firms consider costs in the SHORT and LONG run and FIXED and VARIABLE COSTS Define Short Run rising MARGINAL COSTS. Long run ECONOMIES OF SCALE Relate to specific industries e.g.
Airlines high fixed costs (planes) Mobile phones MASS PRODUCTION/standardised product Oil refining INDIVISIBLE PRODUCTION

Economies of (large) Scale

The advantages of large scale production that result in lower unit (average) costs (cost per unit) Economies of scale the DECISION of the firm about SIZE. Advantage in some markets Singtel establishing cell phone infrastructure expensive (fixed costs) MC of additional user at or near zero (variable costs)

Understanding Long Run Cost Curves

Successful firms GROW ONLY if the market can be extended Growth by product new factories/offices/shops We can say firms DECIDE on different or larger sets of factors of production. Profit maximising firms will choose the lowest cost set. This increase in SIZE is known in economics as a SCALE change. It is useful to TRACK the possible changes in SCALE; this is the LONG RUN AVERAGE COST CURVE In the long run ALL costs are VARIABLE

The COST of SETS OF long run can choose the scale. The entrepreneur in the FACTORS TO PRODUCE OUTPUT Q which would you choose?
A

B C

The LONG RUN is about SIZE and about how best to combine the different factors. Should the firm be; LABOUR INTENSIVE or CAPITAL INTENSIVE or Q [units] LAND INTENSIVE

Sets of Factors
Scale 1

Scale 2

Scale 3

One of these scales will be the MINIMUM EFFICIENT SCALE

Scale 4

The DECISION MAKING period of time. the scale. The entrepreneur in the long run can choose However once the choice is made the firm will move along the SRAC. 1. Potential demand
2. Capital costs $ 3. Confidence inter alia LRAC

There are an INFINITE number of possible scales. 0 Q [units]

As the firm GROWSthe long run can choose the scale. The entrepreneur in scale changes The LRAC shows ALL possible decisions. If the firm is a profit maximiser it will DECIDE to employ the lowest cost set of factors of production.
LRAC 1 2 3 4

Q [units]

Minimum Efficient Scale one combination ofscale. The entrepreneur in the long run can choose the factors will be at the lowest point of the long-run cost curve.

$ 1 2 3 4 5 6

MES

Q [units]

The OPERATINGin the longtime.can choose the scale. The entrepreneur period of run

$ ATC LRAC

Q [units]

The entrepreneur in the long run DIFFERENT. FIRMS/INDUSTRIES AREcan choose the scale. The most productively efficient output depends on the industry we talking about.
$

LRACOR LRACH LRACPUB 0 Q [units]

Internal Economies of Scale

Advantages that result from the growth of the firm Internal economies take place inside the firm
Technical Cubic Capacity Area x 2 Volume x 8; OIL TANKERS Commercial Bulk buying Supermarkets Financial Collateral value of assets Banks Managerial Division of labour; Singtel accountants, marketing, HR Risk Bearing Sales in different countries; Apple

External Economies of Scale

The reduction of costs if the INDUSTRY grows. Support services
The Port in Singapore
Transport Insurance Finance Training university courses

FIRMS may benefit question focus

Firms that continue to grow MAY experience rising costs

Diseconomies of scale
Rising costs of management and control Employment of staff who supervise, measure and monitor but do not contribute directly to output

If the large firm makes SUPERNORMAL PROFIT there is a risk of X-inefficiency. The economies of scale can be shown on a model.

A Typical Long-Run Average Total Cost Curve Costs per unit ($)
60

Increasing returns to scale Economies of Scale Constant Returns to Scale

Decreasing returns to scale Diseconomies of Scale LRAC

55

50 0

10

15

20

40

Minimum Efficient Scale the lowest

point of the LRAC
13-18

Conclusion
The reasons I have given above explain how large firms can may enjoy lower costs. BUT Industries are different Different consumers (MARKET SIZE)
Standardised product big firms Non-standardised product smaller firms

Large firms can also charge lower prices to some customers because they can DISCRIMINATE. (based on price elasticity of demand) Lower prices may also be due to LIMIT or PREDATORY pricing where large firms use their MARKET POWER to reduce competition.

Thesis

Discuss the view that large firms are beneficial in DISCUSS view of the cost-savings they enjoy [13]

Antithesis

Against For shown in part A economies of scale As CAN reduce LRAC. Weaknesses Strengths A number of issues can be discussed Disadvantages Advantages
Competition and marketNegative share Positive EOS as a barrier to market entry

Benefits to who? VALUE JUDGEMENT/ NORMATIVE

Look for the discussion territory before writing Not ALL industries can become large. your answer make some notes. Large market
Standardised product CONSUMER Look out for VALUE JUDGEMENTSCHOICE /NORMATIVE ECONOMICS

Benefits
Producer
Price higher output lower than in a competitive situation. SNP (possible wider benefits)

Society
If the most efficient size involves big firms this may save scarce resources (prevent wasteful duplication) The Public Utilities Board (PUB) for example and the provision of piped water is a NATURAL MONOPOLY that may prevent wasteful duplication.

Stakeholders
Consumers Producers Government Workers Managers Suppliers Society Alternative (real world) objective stakeholder satisficing)

Consumer Benefits
If cost savings are passed on to the consumer. Large firms can SHARE high fixed costs over many outputs. e.g. Exxon-Mobil oil refining litre of fuel less than $2

Exxon-Mobil Singapores largest manufacturing

capital investment costs $5-6 billion

How can Exxon-Mobil sell a litre of petrol for $2 (c)?

Economies of Scale: Effect on average fixed costs for Exxon-Mobil a potential BENEFIT to consumers
y Total Fixed Costs Average and Total Fixed Costs (S$) Average Fixed Costs (AFC) 0 x Quantity (units)

AFC = FC/Q

Workers
Jobs employment Large firms may less FLEXIBLE to changes in consumer demand (IBM?) Unclear whether large firms BENEFIT workers.

The case against Consumers buy goods and services for a variety of reasons COST (PRICE) are not the only influences on demand. Although price may influence our choice of food it is NOT the main reason we buy. Some markets by definition are small There is little scope for economies of scale. The manufacture of jewellery for example is where many people want a more personalised product (and service).

The importance of CONSUMER CHOICE Large firms may dominate markets and reduce consumer choice. Buying a NEW car in Singapore for example there are only a small number of dealers some of whom have a MONOPOLY. There is the potential for consumer exploitation and INEQUITY.

Benefits?
Competition allocative efficiency/ productive efficiency as shown in perfect competition. Markets may be dominated by a small number of large firms.
Restricting consumer choice

Large firms may use PERSUASIVE advertising to encourage sales.

Some people argue that some advertising is a waste of resources Advertising can distort CHOICE.

Large firms may use their MARKET POWER to eliminate smaller more efficient producers predatory pricing.
Microsoft gave away IE killed other browsers

Large firms may use economies of scale as barrier to market entry.

The Inefficiency and Inequity of Monopoly

Price

Deadweight loss
Monopoly price Price in competitive market

Marginal cost

The MC curve CAN be seen as the INDUSTRY SUPPLY curve in perfect competition.
Demand

Marginal revenue
Monopoly Efficient quantity quantity

Quantity

Its the market model

Price

Deadweight loss
Monopoly price Price

Supply

Demand

Monopoly Efficient quantity quantity

Quantity

Examples where large scale is beneficial

Large firms MAY earn SNP and have the CAPACITY to INNOVATE This is most likely in the oligopolistic market structure where non-price competition is important. Cars Pharmaceuticals
Also use of SNP innovation/product development BENEFITS SOCIETY

Price ($)

Where is the competitive SUPPLY curve likely to be?

MC= S in PC

Price in competitive market Monopoly price

MCm

Would the sum of MCs be HERE in perfect competition?

Marginal revenue
Efficient Monopoly quantity quantity

Demand

Quantity

In some industries lower costs (standardised products) are not a consumer benefit.

Clothing (?) limited scope Hairdressing Airlines safety Surgery (?) Can cost cutting lead to lower quality? Large firms X-inefficiency (Leibenstein)

Conclusion
The idea of benefits is complex. There is evidence in some industries - chemicals, oil refining that economies of scale reduce costs AND benefit consumers. Where a non-standardised product is preferred there are fewer benefits from the economies of scale. Producers are aware of these issues. The Apple I-phone is standardised (2 colours) However many people buy cases to protect and personalise their phone. In some industries consumers may receive greater benefits through competition. The hawker centres are unable to benefit from economies of scale and competition between vendors may help to keep prices lower.

Review
There is no single way to write essays Plan (MAKE NOTES you can leave them for the examiner to read if you wish) State answer strategy Read question from time to time Stick to the question focus Hit the HOT BUTTONS in the syllabus Be thoughtful Relate your answer to the real world whenever you can.

QUESTIONS

Average and marginal costs in the S/R

MC AC AVC

Costs ($)

z y x AFC

Output (Q)