Growth & (Dis)economies of scale


    Growth: Most business start small then grow. Business like to grow because the benefits can be very attractive, for example revenues will be higher, unit costs are likely to be lower and the business will have a larger profile with a greater market share.

    Economies of Scale:

    In figure 1 a firm is currently producing in a small plant and its short-run costs are SRAC. When it produces an output equal to Q1 its average cost will be AC1. If it raises production to Q2 average costs will rise to AC2. This is the result of the law of diminishing returns.

    If the firm expands the scale of its operations (which it can do in the long run) the same level of output can be produced more efficiently. With a bigger plant, represented by SRAC2. Q2 can be produced at an average cost of just AC3. Long run average costs fall due to economies of scale and will continue to do so until the firms have built a plant which minimises long run average costs. In the diagram this occurs when a plant show by SRAC3 is built. This is sometimes called the minimum efficient scale of plants. When output reaches Q* in this plant long run average costs cannot be reduced any further through expansion. The business is said to be productively efficient at this point.

    At any output level higher or lower than Q*, the business is productively inefficient because average costs could be lower. For example, if the firm continues to grow it will experience rising average costs due to diseconomies of scale, as in SRAC4 in figure 1.



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