E-LESSON-8 MICRO ECONOMICS

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BBA/BCOM 2 All right are reserved with CU-IDOL Economies and Diseconomies of Scale Course Code: BBA103/BCM103 Semester: First e-Lesson: 8 SLM Unit: 8 www.cuidol.in Unit-8 (BBA103/BCM103)

MICRO ECONOMICS 33 OBJECTIVES INTRODUCTION To enable the students to describe the In this unit we are going to learn economies of scale. about economies and diseconomies of scale. To analyze and understand the returns to scale. Under this you will learn and understand the Returns to scale. To evaluate, analyze and interpret the You will understand the types of reasons behind the economies or returns to scale. diseconomies of scale. INSTITUTE OF DISTANACEll ArNigDhtOaNrLeINreEsLeErAvRedNIwNiGth CU-IDOL www.cuidol.in Unit-8 (BBA103/BCM103)

TOPICS TO BE COVERED 4 Introduction to the concept of Returns to Scale. Types of Scale(Increasing, constant and Decreasing ) Concept of internal and external economies. www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Economies of Scale 5  The term ‘economies’ refers to the cost advantages. Such advantages may result from either extending the scale of production or exploring the scope of production.  Economies of scale explain the down sloping part of the long run AC curve. As the size of the plant increases, LAC typically declines over some range of output for a number of reasons.  The most important is that, as the scale of output is expanded, there is greater potential for specialisation of productive factors. This is most notable with regard to labour but may apply to other factors as well. www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Returns to Scale 6  It refers to manner of change in output cost by the increase in all the input simultaneously and in the same proportion.  Returns refers to “change in physical output” Scale refers to “quantity of input employed” Change in scale means that all factors of production are increased or decreased in same proportion. Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL www.cuidol.in

Types of Return of scale 7 Returns to scale may be:  - Increasing returns to scale  - Constant returns to scale  - Decreasing returns to scale www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Increasing Returns of scale 8  When percentage (%) increase in all factor inputs causes proportionately greater increase in output it is (IRS) It is also known as stage of decreasing cost  This stage occurs due to economies of large scale Production  When a firm expands, increasing IRS obtained in beginning www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Example 9  If the amount of inputs are doubled and the output increases by more than double, it is said to be an increasing returns to scale.  When there is an increase in the scale of production, it leads to lower average cost per unit produced as the firm enjoys economies of scale. Reasons  More division of labor  Use of specialized machines www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Constant Returns of scale 10  When percentage increase in all factor inputs causes equal proportionate increase in output  It is known as “linear homogeneous production function”  CRS operates when firm has achieved the point of maximum capacity  So this stage occurs due to combine effect of economies and diseconomies of scale www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Example 11 If a firm doubles inputs, it doubles output. In case, it triples output. The constant scale of production has no effect on average cost per unit produced. www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Decreasing Returns of scale 12  When percentage increase in all factor inputs causes proportionately less increase in output  Generally there is a level after which output increases in a smaller proportion as compare to increase in the amount of factor inputs.  DRS occurs, if firm keeps on increasing the inputs even after the stage of optimum capacity  This stage also known as stage of increasing cost and occurs because of economies of large scale production www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Example 13  If a firm increases inputs by 100% but the output decreases by less than 100%, the firm is said to exhibit decreasing returns to scale.  In case of decreasing returns to scale, the firm faces is economies of scale.  The firm's scale of production leads to higher average cost per unit produced Reasons  Difficulty in coordination and management  Technical diseconomies  Limited availability of factors of production www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

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Economies of scale 15 Cost per unit decreases when quantity produced increases  Economies of scale is a cost advantage that an enterprise obtain due to expansion. It leads to the result in lower unit cost.  Economies of scale occur when increased output leads to lower unit costs or firm's marginal costs of production decrease  Company A producing 100 units of ball, where cost per unit is Rs. 50. At the same time, Company B producing 1000 units of ball, where cost per unit is Rs. 30 .  The diagram shows that as firms increase output from Q1 to Q2, average costs fall from AC1 to AC2. Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL www.cuidol.in

Diseconomies of scale 16 A firm sees an increase in marginal costs when output is increased when business organization become so big or inefficient  An overcrowding effect within an organization is often the leading cause of diseconomies of scale. This happens when a company grows too quickly, thinking that it can achieve economies of scale in early stage  The reason behind can be over production, less efficient employees, over crowd etc.  For example, you might think that adding some machineries to the factory will increase the output may increases , but cost per unit (Marginal cost)also gradually increases. production, it will leads to appoint more employees to operate those machineries. www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

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Economies of Scale 18 The economies of Scale are classified as: • Internal Or Real Economies • External or Pecuniary Economies www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Internal or Real Economies 19 As a firm increases its scale of production, the firm enjoys several economies named as internal economies. Basically, internal economies are those which are special to each firm. For example, one firm will enjoy the advantage of good management; the other may have the advantage of specialisation in the techniques of production and so on. Those Specifically related to the business or firm itself 1. Production 2. Technical 3. Marketing 4. Financial 5. Specialisation Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL www.cuidol.in

External or Pecuniary Economies 20 External economies refer to all those benefits which accrue to all the firms operating in a given industry. Generally, these economies accrue due to the expansion of industry and other facilities expanded by the Government. External economies accrue to the expanding firms from the advantages arising outside the firm, from the advantages arising outside the firm. External Economies follow to the large size firms in the form of discounts and concessions on, 1. Bulk purchase of raw material 2. Large scale purchase of external Finance 3. Massive Advertisement Campaigns 4. Large Scale hiring of means of transport and warehouses www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Diseconomies of Scale 21 The diseconomies of scale are two: • Internal diseconomies of scale and • External diseconomies of scale www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Internal Diseconomies 22  Economic theory also predicts that a single firm may become less efficient if it becomes too large.  Like everything else, economies of scale have a limit too. This limit is reached when the firm facing some negative factors. Such as : 1. Poor communication 2. Coordination problem 3. Low of motivation of employees 4. Lack management 5. Difficulty in team work www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

External Diseconomies 23 External diseconomies are the advantages that arise outside the firm .Average cost eventually rise because of diseconomies of scale  For example, negative externalities like road congestion, can impact the growth of an industry External factors beyond the control of a company www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Multiple Choice Questions 24 1. A firm encountering economies of scale over some range of output will have a: A) rising long-run average cost curve. B) falling long-run average cost curve. C) constant long-run average cost curve. D) rising, then falling, then rising long-run average cost curve 2. When a firm doubles its inputs and finds that its output has more than doubled, this is known as: A) economies of scale. B) constant returns to scale. C) diseconomies of scale. D) a violation of the law of diminishing returns. Answers: 1. B) 2. A) www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

Multiple Choice Questions 25 3. If all resources used in the production of a product are increased by 20 percent and output increases by 20 percent, then there must be: A) economies of scale. C) constant returns to scale. B) diseconomies of scale. D) increasing average total costs 4. Economies and diseconomies of scale explain why the: A) short-run average fixed cost curve declines so long as output increases. B) marginal cost curve must intersect the minimum point of the firm's average total cost curve. C) long-run average total cost curve is typically U-shaped. D) D) short-run average variable cost curve is U-shaped. Answers: 3. C) 4.C) Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL www.cuidol.in

SUMMARY 26  Economies of scale explain the down sloping part of the long run AC curve.  Returns to scale It refers to manner of change in output cost by the increase in all the input simultaneously and in the same proportion.  Increasing returns to scale or diminishing cost refers to a situation when all factors of production are increased, output increases at a higher rate.  Diminishing returns or increasing costs refer to that production situation, where if all the factors of production are increased in a given proportion, output increases in a smaller proportion.  Constant returns to scale or constant cost refers to the production situation in which output increases exactly in the same proportion in which factors of production are increased.  Internal Economies - As a firm increases its scale of production, the firm enjoys several economies named as internal economies.  External Economies: External economies refer to all those benefits which accrue to all the firms operating in a given industry. Generally, these economies accrue due to the expansion of industry and other facilities expanded by the Government. www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

FAQ’S 27 Q.1 What is meant by Diseconomies of scale? Ans : It is a state where the long run average cost (LRAC) of production increases with the increase in per unit of goods produced. Diseconomies of scale occur when the firms outgrow in the size which results in the increase in employee cost, compliance cost, administration cost etc. Q.2 Explain in detail the return to scale ? Ans: Three types –increasing ,constant and diminishing return to scale with the help of diagram. For more kindly refer to SLM. Q3. Name different types of internal and external economies of large scale production. Ans. Internal economies of large scale production can be grouped into: (a) Technological, (b) Managerial, (c) Marketing, (d) Financial, and (e) Risk Distributional Economies. External economies are of the following types: (a) Economies of localisation, (b) Economies of research and information, and (c) Economies of specialisation. www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

References 28 1. Dwivedi D.N. , Managerial Economic, Vikas Publications, New Delhi. 2. Mithani D.M. , Managerial Economics Theory and Applications, Himalaya Publication, Mumbai. 3. https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals- exams-study-resources/f1/technical-articles/introduction-to-microeconomics.html 4. https://www.toppr.com/guides/economics/microeconomics-and- macroeconomics/introduction-to-microeconomics/ 5. http://wikieducator.org/Introduction_to_Economics_and_Microeconomic_Theory www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL

29 THANK YOU For queries Email: [email protected] www.cuidol.in Unit-8 (BBA103/BCM103) All right are reserved with CU-IDOL