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Explain the different types of economies of scale - Discuss which economies are likely to occur as a result of a) horizontal integration b) vertical integration.

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Introduction

, Explain the different types of economies of scale. Discuss which economies are likely to occur as a result of a) horizontal integration b) vertical integration. Economies of scale are said to exist when in the long run (all factors of production are variable) costs fall as output increases. This is due to firms expanding in size and output, which causes the long run average costs to fall. These economies of scale are experienced as the business expands until a point is reached where average costs are constant as output increases. After this point if the business expands anymore, it is likely to experience diseconomies if scale and decreasing returns to scale will set in. Therefore the long run average cost curve is U-shaped. Economies of scale are reached through a variety of ways. Different sources of economies of scale are technical economies, managerial economies, purchasing & marketing economies and financial economies. ...read more.

Middle

Marketing is also less expensive if there are a larger number of products being advertised, and so larger firms can enjoy lower average costs due t economies of scale. The forth source of economies of scale is financial economies. Small firms find it expensive to raise new investment funds and loans are also given at relatively high interest rates as it is seen as a bigger risk to the bank to loan money to a small firm with little or no collateral which could easily go bankrupt, than it would be to loan money to a large firm. Therefore large firms often have low interest rates on bank loans, and also are able to raise money from sales of shares, and so achieve lower average costs. Many firms choose to merge rather than grow internally as it is often cheaper to do so and easier and quicker to become much larger and experience lower average costs through economies of scale. ...read more.

Conclusion

Vertical mergers/integration occurs when two firms at different production stages of the same industry merge to form one large company. There are two types of vertical integration, forward and backward. Forward integration involves a supplier of one product merging with one of its buyers, i.e. a car manufacturer buying a dealership. Whereas backward integration involves the company buying one of its suppliers, i.e. a car manufacturer buying a tyre company. Vertical integration is less likely to result in economies of scale than horizontal integration. This is because there are unlikely to be any technical economies between the two firms. However there may be some marketing economies as only one marketing department would be required thus lowering costs in that aspect of the firm. However it is more likely with vertical integration, that there will be financial economies. This is due to the fact that the company would have grown significantly and would therefore have much more collateral and become a lower risk to banks lending them money, so a lower interest rate will be achieved, causing average costs to fall due to economies of scale. ...read more.

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