Answer to Question #244527 in Microeconomics for james

Question

With the aid of a diagram, distinguish between internal economies of scale and internal diseconomies of scale. Give two examples of each

Answer 1

Economies of scale means when quantity of output is increased, there is decline in the average cost of production. The decline in average cost, with rise in quantity of production is due to increased efficiency, specialization of labor, purchasing inputs in bulk at cheaper rates, etc. Thus, up-to a particular point, as quantity of output is increased, we notice a decline in average cost of production. Thus, we say firm is experiencing economies of scale.

But the firm only experiences decline in average costs of production up-to certain level of output. Further increase in output does not leads to decline in average costs. Thus we say that the firm has achieved minimum efficient scale of production. Minimum efficient scale is when the firm is producing such quantity of output where average total costs are minimum.

If the firm keeps on increasing the output, then after a certain point, the firm starts experiencing dis-economies of scale which means increase in output leads to increase in average cost of production. This happens because now the firm is producing such a large level of output where it is incurring mismanagement in the production process which leads to increased mistakes and thus leading to increase in costs. Large level of output requires more inputs like labor, managers, supervisors, etc which add to the cost of production. Thus firm experiences dis-economies of scale i.e increase in average costs of production as output is increased.

 

LRATC = Long run average total cost curve

From point a to b, firms experiences economies of scale i.e as quantity of output is increased, there is decline in average costs of production.

From point b to c, firm operates on minimum efficient scale i.e the average total costs are minimum.

From point c to d, firm experiences dis-economies of scale i.e as quantity of output is increased, there is decline in average costs of production.