Economics questions - economies of scale.

2. Define and explain all Internal Diseconomies of Scale:

• Internal Diseconomies of Scale: Are increases in long-run average cost as the size and output of a firm increases too much. Although firms benefit from Internal Economies of Scale by becoming larger, there is a point where a firm may become too large and as a result average cost may begin to rise. The advantages of Internal Economies of Scale are lost by the disadvantages of Internal Diseconomies of Scale.

• Managerial Diseconomies – Many managers can be an advantage but having to many can make the organization of production very complicated and more costly. Too many managers lead to co-ordination and communication problems. Decisions are more difficult and take longer to reach. So it is easier to lose control of costs that rise faster than output. As a result the average cost of the firm begins to rise.
• Labour Diseconomies – Large firms may have more problems in the relations between the employers and labour than small firms. The main reason is that division of labour used by large firms makes workers very bored with their repetitive jobs. So they become less co-operate and the quality of the products they produce falls.  As a result strikes are more likely to occur in very large firms.

3. Define and explain all External Economies of Scale:

• External Economies of Scale: Are reductions in long-run average costs than become available to firms belonging to an industry which has grown in size. When the whole industry expands, the firms in the industry may enjoy lower average costs. So it is more likely to small firms that belong to large industries to enjoy External Diseconomies of Scale. So they enjoy certain advantages.

• Skilled Labour and Training Facilities – Certain areas have a tradition in certain industries and they are more likely to have a supply of skilled labour. E.g. The tourist areas of Famagusta and Paphos are more likely to have supply if skilled labour needed for the tourist industry than other areas. Some firms might provide training courses related to the industry and this would reduce a firm’s costs of training new workers itself.
• Development of Subsidiary Industries – A concentrated industry may also benefit by attracting specialist firms providing materials, components, and services for the main industry. E.g. Firms producing car components operate in areas where the car industry is concentrated. Car manufacturers can attract the firm producing car components to build a place in the same area to reduce its costs pf transporting components.

4. Define and explain all External Diseconomies of Scale:

• External Diseconomies of Scale: Are increases in the long-run average costs for a firm when the industry in which the firm operates becomes too large. They have two disadvantages.

• Shortages of Resources – If the industry grows too large there could be shortages in the supplies of resources used by the industry. Such resources could be skilled labour, raw materials or components. Competition between firms that need these resources leads to an increase in their price, which means an increase in the costs of the firm. E.g. A shortage of skilled workers from labour will encourage firms to offer higher wages to attract workers from other firms.
• Diseconomies of Concentration – Some advantages exist to a firm when the industry it belongs to, is concentrated in the same area. If too many firms are concentrated in the same area problems begin to appear. Roads may become full, leading to higher transport costs. Workers may become less willing to work in the industry if the cost of houses rises and results in an overcrowded polluted town. Only the offer of higher wages will convince them to stay and work. This raises the firm’s costs of production.

5. How firms grow?

As firms grow larger they may have many benefits. The main one is the ability to enjoy Internal Economies of Scale. Firms can grow in two other main ways:

• Internal growth: Is achieved when a firm expands on its own. It uses its own resources to invest and increase its production and sales. This method is very slow and might take many years.
• Integration or amalgamation: It occurs when two or more firms combine to form one firm. A major advantage of integration is all the internal economies of scale that the new larger firm will enjoy. A firm can integrate in one of these two ways:

• A take-over occurs when one company buys all or at least 50% of the shares in the ownership of another company. The firm being taken-over loses its own identity and becomes part of the other company.
• A merger, occurs when two or more firms agree to join to form a new firm. This is usually done by shareholders of the two or more companies exchanging their shares for the new shares of the new company. There are three main types of integration or amalgamation:

1. Horizontal Integration, occurs when the firms joining together are in the same industry and at the same stage of production. E.g. When a bank takes over another bank, both companies are in the banking industry.
2. Vertical integration, occurs when the firms joining together are in the same industry but at different stages of production. There are three types of vertical integration: 

The first one is the Forward Vertical Integration, which occurs when a firm joins together with another involved at a later stage of production. E.g. If a chicken farm joins with KFC then it will have a guaranteed market in which to sell its products.

The second one is the Backward Vertical Integration, which occurs when a firm joins together with another involved at an earlier stage of production. E.g. If KFC joins with a chicken farm, to ensure a non-stop supply of raw materials and avoid the danger that they may come under the control of a competition or to be protected against a rise in the price of chickens.

3. And the third one is the Lateral integration, which takes place when the firms joining together are in different industries. The main reason for this is in case the demand of one product falls, the firms may still survive from the sale of its other products.

6. How can firms increase their total profit?

They can achieve that by raising total revenue and by lowering total costs.

Average Cost is the cost per unit of output. It is equal to total cost divided by total output.

7. Using a diagram, explain how we can find the optimum size of a firm:

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The optimum size of a firm is the size or output at which it can produce most efficiently and therefore at the lowest cost. At OQ the firm is enjoying Internal Economies of Scale and its average cost falls. Beyond this point, further growth would make the firm less efficient. Instead of producing with a low average cost, extra production would cause the average cost of each unit of output to rise.

8.  Why do small firms still exist?

• New firms – Firms do not start large. In other words. Many firms are small because they are new. Those that will be successful are expected to become large over the years.
• Desire to remain in control – Sometimes owners of small firms may not want the firm to grow too large in case they lose personal control.
• Lack of Finance – Small firms find it difficult to expand because they cannot raise finance. Large companies have huge retained profits and also can sell shares to the general public. Small firms can neither of these.