Exercises: Economies and Diseconomies of Scale

Define economies of scale and diseconomies of scale. Explain how each affects a firm's long-run average cost.

Classify each of the following as an internal or external economy of scale:

1. a) A Cork food manufacturer buys ingredients in bulk at a lower price per unit.

1. b) A skilled workforce develops in the Shannon region around several aerospace firms.

1. c) A large Irish retailer borrows at a lower interest rate than a small shop.

1. d) A new motorway reduces delivery costs for all firms in a region.

A firm's long-run average cost falls from €12 per unit at 1,000 units to €9 per unit at 2,000 units.

1. a) Calculate total cost at each output.

1. b) Calculate the percentage fall in average cost.

1. c) State what type of scale effect this shows.

A Dublin printing firm has the following long-run average costs:

1. a) Identify the ranges of output with economies of scale, constant returns to scale and diseconomies of scale.

1. b) Calculate total cost at 30,000 and 60,000 units.

1. c) Identify the minimum efficient scale and explain its meaning.

A growing Irish dairy co-operative expands from one plant to three. Its management reports that unit costs fell at first because of bulk purchasing and specialised machinery, but later rose because of coordination problems and slower communication.

1. a) Identify two economies of scale and two diseconomies of scale mentioned or implied.

1. b) Sketch in words the shape of the long-run average cost curve described.

1. c) Suggest two measures management could take to limit diseconomies of scale.

A small Irish firm doubles all its inputs (labour, capital and materials) and output rises from 500 to 1,100 units. Total cost rises from €10,000 to €20,000.

1. a) Calculate average cost before and after the expansion.

1. b) Explain whether the firm experiences economies or diseconomies of scale.

1. c) Explain why the doubling of all inputs is a long-run, not short-run, change.

The Irish government is considering whether small Irish manufacturers should merge to compete in export markets. Evidence shows that the minimum efficient scale in the industry is 80,000 units per year, while the typical Irish firm produces 20,000 units.

1. a) Explain how this evidence supports a case for mergers, referring to economies of scale.

1. b) Discuss two possible disadvantages of merging, including diseconomies of scale.

1. c) Explain how Ireland's small domestic market and membership of the EU single market affect the importance of reaching minimum efficient scale.

1. d) Evaluate whether mergers or export growth would be the better route for a small Irish firm to reduce its average costs.

A firm's long-run total cost is $LTC = 500Q - 8Q^2 + 0.1Q^3$ for $Q$ in hundreds of units.

1. a) Derive the long-run average cost function.

1. b) Find the output at which LRAC is minimised by setting its derivative equal to zero, and calculate the minimum LRAC.

1. c) State the range of output with economies of scale and the range with diseconomies of scale.

1. d) Explain how this result might influence the firm's decision on plant size.

An Irish multinational with plants in Cork and Galway considers consolidating production at one site. Consolidation would cut average cost from €40 to €32 per unit at an output of 50,000 units, but would require redundancy payments of €300,000 and lengthen delivery times to some customers.

1. a) Calculate the annual saving from consolidation and the payback period for the redundancy cost.

1. b) Discuss non-cost factors the firm should weigh, including effects on regional employment.

1. c) Distinguish between internal and external economies of scale in this context and say which are mainly involved.

1. d) Make and justify a recommendation.