Explain Economies of scale and its types ?

1. Internal economies of scale

■ Financial economies of scale

It is cheaper for larger firms to access finance because they present a lower risk than small firms.
For this reason they will find it easier to get loans and overdrafts from banks. Furthermore, the
terms of the loan, such as the interest rate to be paid and the length of time allowed before
repayment, will be more favourable. In effect, the cost of borrowing will be cheaper for larger
firms

■ Purchasing economies of scale

Greater output means that materials can be bought in bulk at lower cost. Thus large firms can
buy materials much more cheaply than small firms. Large firms can also use their size to bargain
with suppliers, since many of these suppliers will rely on these large firms continuing to buy the
items that they make. Large firms, such as supermarkets, have been able to use this bargaining
power to keep down prices of products such as milk.

■ Marketing economies of scale

Costs such as advertising can be spread over more units of output if a firm produces on a large
scale and so advertising campaigns tend to be more cost effective for large firms. Smaller firms
cannot afford to use expensive forms of media, such as television advertising, and therefore are
less likely to be successful. The internet and online advertising has reduced many costs of
advertising and so this economy is less prominent than it was when TV advertising dominated
advertising and promotions. However, sophisticated databases still enable larger firms to be able
to target their marketing more effectively than most small firms.

■ Risk-bearing economies of scale

Large firms often diversify into different products and different markets. They can also ensure
that they have a choice of suppliers when ordering supplies. These actions help to protect such
firms from sudden changes such as a fall in demand, a decline in a particular market or the
liquidation of a supplier. The firm is less at risk from the detrimental effects of these changes
because it has alternative products to sell or suppliers from which to buy materials. It should be
noted that risk-bearing economies may protect a firm from the risk of over specialisation, but this
can mean that the firm is operating in so many markets that it may not fully exploit the other
internal economies of scale.
 2. External economies of scale

If a firm operates within a large industry, this can help it to reduce its average costs regardless of
its size, especially if it is located in a place where that particular industry is concentrated.
Examples of external economies of scale are:

■ Economics of Localization

Cost of production reduces due to number of firms are located at one place example : All raw
material are available at one place.

■ Training and education

Local colleges and universities will offer courses suited to the local community, thus helping all
firms involved in the main industries in that area. Training firms will also provide facilities and
courses geared towards the needs of the local community.

■ Reputation

Sometimes a city or area gains an excellent reputation for the provision of a certain good or
service. This can greatly assist firms that are located in that city or area, as they can use its
reputation to boost sales of their goods.

Explain Long-Run Average Total Cost (LRATC) and U shaped long run average Total cost
and Long run Marginal Cost ?

Long-run average total cost (LRATC) is a business metric that represents the average cost per
unit of output over the long run, where all inputs are considered to be variable and the scale of
production is changeable. The long-run average cost curve shows the lowest total cost to produce
a given level of output in the long run.

Long-term unit costs are almost always less than short-term unit costs because, in a long-term
time frame, companies have the flexibility to change big components of their operations, such as
factories, to achieve optimal efficiency. A goal of both company management and investors is to
determine the lower bounds of LRATC.

 Long Run Marginal Cost:

Long run Marginal Cost (LMC) is defined as added cost of producing an additional unit of a
commodity when all inputs are variable. This cost is derived from short run marginal cost.
Productio Quantity Fixed Variable Total Long run Long run
n year produced cost cost cost average cost Average
Per Units marginal cost per
unit Analysis
X A B A+B A+B/X
1 100 units 5000 4000 rs 9000 rs 9000/100 = 90 -
rs rs
2 200 units 5000 7000 12000 12000/200 = 90-60=30
60
3 300 units 5000 7500 12500 12500/300 = 60-41.66=18.3
41.66
4 400 units 5000 8000 13000 32.5 41.66-32.5=9.1
5 500 units 5000 9000 14000 28 32.5-28=4.5
6 Economies of scale 600 units 5000 10000 15000 25 28-25=3
7 Dis Economies 700 units 5000 14000 19000 27.14 25-27.14=-2.14
of scale
8 800 units 5000 18500 23500 29.37 27.14-29.37=-2.23
9 900 units 5000 24500 29500 32.77 29.37-32.77=-3.4
10 1000 5000 28500 33500 33.5 32.77-33.5=-.73
units
 Long Run Marginal Cost:
Long run Marginal Cost (LMC) is defined as added cost of producing an additional unit of a
commodity when all inputs are variable. This cost is derived from short run marginal cost.

Figure in Rs.
Fixed
Total Long run Marginal Marginal Long run
Quantity cost + cost Average cost Total Cost unit of Marginal
produce Variabl Per Units Production cost(Curve)
e cost
d
X A+B A+B A+B/X M N M/N
100 units 9000 9000/100 = 90 - - -
200 units 12000 12000/200 = 60 12000- 200- 3000/100=30
9000=3000 100=100

300 units 12500 12500/300 = 12500- 300- 500/100=5

41.66 12000=500 200=100
400 units 13000 32.5 13000- 400- 500/100=5
12500=500 300=100
500 units 14000 28 14000- 500- 1000/100=10
13000=1000 400=100
600 units 15000 25 15000- 600- 1000/100=10
Economic of scale
14000=1000 500=100
700 units 19000 27.14 19000- 700- 4000/100=40
Dis Economic of scale
15000=4000 600=100
800 units 23500 29.37 23500- 800- 4500/100=45
19000=4500 700=100
900 units 29500 32.77 29500- 900- 6000/100=60
23500=6000 800=100
1000 33500 33.5 33500- 1000- 4000/100=40
units 29500=4000 900=100