<< Chapter < Page Chapter >> Page >

[link] illustrates the idea of economies of scale, showing the average cost of producing an alarm clock falling as the quantity of output rises. For a small-sized factory like S, with an output level of 1,000, the average cost of production is $12 per alarm clock. For a medium-sized factory like M, with an output level of 2,000, the average cost of production falls to $8 per alarm clock. For a large factory like L, with an output of 5,000, the average cost of production declines still further to $4 per alarm clock.

Economies of scale

The graph shows a downward sloping line that represents how large-scale production leads to a decrease in average costs.
A small factory like S produces 1,000 alarm clocks at an average cost of $12 per clock. A medium factory like M produces 2,000 alarm clocks at a cost of $8 per clock. A large factory like L produces 5,000 alarm clocks at a cost of $4 per clock. Economies of scale exist because the larger scale of production leads to lower average costs.

The average cost curve in [link] may appear similar to the average cost curves presented earlier in this chapter, although it is downward-sloping rather than U-shaped. But there is one major difference. The economies of scale curve is a long-run average cost curve, because it allows all factors of production to change. The short-run average cost curves presented earlier in this chapter assumed the existence of fixed costs, and only variable costs were allowed to change.

One prominent example of economies of scale occurs in the chemical industry. Chemical plants have a lot of pipes. The cost of the materials for producing a pipe is related to the circumference of the pipe and its length. However, the volume of chemicals that can flow through a pipe is determined by the cross-section area of the pipe. The calculations in [link] show that a pipe which uses twice as much material to make (as shown by the circumference of the pipe doubling) can actually carry four times the volume of chemicals because the cross-section area of the pipe rises by a factor of four (as shown in the Area column).

Comparing pipes: economies of scale in the chemical industry
Circumference ( 2 π r ) Area ( π r 2 )
4-inch pipe 12.5 inches 12.5 square inches
8-inch pipe 25.1 inches 50.2 square inches
16-inch pipe 50.2 inches 201.1 square inches

A doubling of the cost of producing the pipe allows the chemical firm to process four times as much material. This pattern is a major reason for economies of scale in chemical production, which uses a large quantity of pipes. Of course, economies of scale in a chemical plant are more complex than this simple calculation suggests. But the chemical engineers who design these plants have long used what they call the “six-tenths rule,” a rule of thumb which holds that increasing the quantity produced in a chemical plant by a certain percentage will increase total cost by only six-tenths as much.

Shapes of long-run average cost curves

While in the short run firms are limited to operating on a single average cost curve (corresponding to the level of fixed costs they have chosen), in the long run when all costs are variable, they can choose to operate on any average cost curve. Thus, the long-run average cost (LRAC) curve    is actually based on a group of short-run average cost (SRAC) curves , each of which represents one specific level of fixed costs. More precisely, the long-run average cost curve will be the least expensive average cost curve for any level of output. [link] shows how the long-run average cost curve is built from a group of short-run average cost curves. Five short-run-average cost curves appear on the diagram. Each SRAC curve represents a different level of fixed costs. For example, you can imagine SRAC 1 as a small factory, SRAC 2 as a medium factory, SRAC 3 as a large factory, and SRAC 4 and SRAC 5 as very large and ultra-large. Although this diagram shows only five SRAC curves, presumably there are an infinite number of other SRAC curves between the ones that are shown. This family of short-run average cost curves can be thought of as representing different choices for a firm that is planning its level of investment in fixed cost physical capital—knowing that different choices about capital investment in the present will cause it to end up with different short-run average cost curves in the future.

Questions & Answers

QI: (A) Asume the following cost data are for a purely competitive producer: At a product price Of $56. will this firm produce in the short run? Why Why not? If it is preferable to produce, what will be the profit-maximizing Or loss-minimizing Output? Explain. What economic profit or loss will the
Falak Reply
what is money
DAVY Reply
what is economic
Stephen Reply
economics is the study of ways in which people use resources to satisfy their wants
Falak
what is Price mechanism
Dhany Reply
introduction to economics
Uday Reply
welfare definition of economics
Uday
examine the wealth and welfare definitions of economics
Uday
read book by ml jhingan
Anand
What do we mean by Asian tigers
Aeesha Reply
Dm me I will tell u
Shailendra
Hi
Aeesha
hi
Pixel
What is Average revenue
KEMZO
How are u doing
KEMZO
it is so fantastic
metasebia
uday
Uday
it is a group of 4 countries named Singapore, South Korea, Taiwan and Hong Kong because their economies are growing very faster
Anand
what's a demand
Edward Reply
it is the quantity of commodities that consumers are willing and able to purchase at particular prices and at a given time
Munanag
quantity of commodities dgat consumers are willing to pat at particular price
Omed
demand depends upon 2 things 1wish to buy 2 have purchasing power of that deserving commodity except any from both can't be said demand.
Bashir
Demand is a various quantity of a commodities that a consumer is willing and able to buy at a particular price within a given period of time. All other things been equal.
Vedzi
State the law of demand
Vedzi
The desire to get something is called demand.
Mahabuba
what is the use of something should pay for its opportunity foregone to indicate?
Random Reply
Why in monopoly does the firm maximize profits when its marginal revenue equals marginal cost
astrid Reply
different between economic n history
Falma Reply
If it is known that the base change of RM45 million, the statutory proposal ratio of 7 per cent, and the public cash holding ratio of 5 per cent, what is the proposed ratio of bank surplus to generate a total deposit of RM 300 million? 
Jeslyne Reply
In a single bank system, a bank can create a deposit when it receives a new deposit in cash. If a depositor puts a cash deposit of RM10,000 into the bank, assume the statutory reserve requirement is 7% and the bank adopts a surplus reserve of 8%. a. Calculate the amount of deposits made at the end o
Jeslyne
the part of marginal revenue product curve lies in the _ stage of production is called form demand curve for variable input.
Bashir Reply
The cost associated with the inputs owned by the farmer is termed as
Bashir
the cost associated with inputs owned by the farmer is termed as ____
Bashir
why do we study economic
Nwobodo Reply
we study economics to know how to manage our limited resources
Eben
တစ်ဦးကျဝင်​ငွေ
myo
we study economics the know how to use our resources and where to put it
Mamoud
what is end
Nwobodo
we study economics to make rational decision
Gloria
we study economics only to know how to effectively and efficiently allocate our limited resource in other to meet our unlimited wants
Kpegba
We study economics inorder for us to know the difference of the needs and wants and aslo how to use the limited resources that are available
Bongani
who is the father of economy
Yajanyi Reply
adam smith
ibrahim
Adam smith
Somnath
professor Lionel Robins
Abraham
adam smith
albert
mariginal utility is finalized by who?
Barsharani
marshall
Aadi
Adam Smith
Laila
Adam smith
Mamoud
Adam Smith
Bongani
Adam smith
Veronica
adam smith barter system
Omed
why we study economics
Kitojo Reply

Get Jobilize Job Search Mobile App in your pocket Now!

Get it on Google Play




Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of economics' conversation and receive update notifications?

Ask