economies of scale and resource mix
DESCRIPTION
This revision presentation looks at the operational issue of business scale. What are economies of scale and should a business adopt a capital or labour intensive business model?TRANSCRIPT
Economies of Scale &
Resource Mix
Economies of Scale &
Resource Mix
Unit costs formula
Average cost per unit is calculated using this formula:
Total production costs in period (£)
Total output in period (units)
Economies of scale
Arise when unit costs fall as
output increases
Arise when unit costs fall as
output increases
Economies of scale illustratedAverageCost perUnit (£)
Quantity of output
CostCurve
AC1
AC2
Q1 Q2
Unit costs are falling as output increases from Q1 to Q2
= economies of scale
Unit costs are falling as output increases from Q1 to Q2
= economies of scale
Unit costs start to rise as output rises above Q3
= diseconomies of scale
Unit costs start to rise as output rises above Q3
= diseconomies of scale
Q3
Minimum efficient scale
The output at which average unit costs of
production are at their minimum
The output at which average unit costs of
production are at their minimum
Internal v External Economies of Scale
Arise from the increased output of the business itself
Arise from the increased output of the business itself
InternalInternalOccur within an industry:
i.e. all competitors
benefit
Occur within an industry:
i.e. all competitors
benefit
ExternalExternal
Internal economies of scale
Buying economies
Buying in greater quantities usually results in a lower price (bulk-buying)
Technical Use of specialist equipment or processes to boost productivity
Marketing Spreading a fixed marketing spend over a larger range of products, markets and customers
Network Adding extra customers or users to a network that is already established (e.g. mobile phones)
Financial Larger firms benefit from access to more and cheaper finance
External economies of scale
• Arise from the industry as a whole – i.e. all competitors benefit
• Often associated with particular geographic areas– E.g. Creative & media in London
• Examples– Having many specialist suppliers close by– Access to research and development facilities– Pool of skilled labour to choose from
Diseconomies of scale
Factors which cause the average production cost per unit of a business to
increase above the efficient level
Factors which cause the average production cost per unit of a business to
increase above the efficient level
Examples of diseconomies of scale
• Poor communication• More difficult to control a larger,
more complex business• More frequent machinery &
employee breakdown if output & capacity utilisation is too high
• Loss of management focus
The resource mix
What is the optimal mix of labour and capital in a business?
Labour IntensiveLabour Intensive
Labour versus Capital intensity
Production relies on using labour
resources
Production relies on using labour
resources
Capital IntensiveCapital Intensive
Production relies on using capital
resources
Production relies on using capital
resources
Examples of labour / capital intensive industries
Labour intensive Capital intensive
Food processing Oil extraction & refining
Hotels & restaurants Car manufacturing
Fruit farming Web hosting
Hairdressing Intensive arable farming
Coal mining Transport infrastructure
Implications of intensity
Labour intensive Capital intensive
Labour costs higher than capital costs
Capital costs higher than labour costs
Costs are mainly variable= lower breakeven output
Costs are mainly fixed = higher breakeven output
Firms benefit from access to sources of low-cost labour
Firms benefit from access to low-cost, long-term financing
Benefits and drawbacks of capital intensive
Benefits Drawbacks
Greater opportunities for economies of scale
Significant investment
Potential for significantly better productivity
Potential for loss competitiveness due to obsolescence
Better quality & speed (depending on product)
May generate resistance to change from labour force
Lower labour costs
Benefits and drawbacks of labour intensive
Benefits Drawbacks
Unit costs may still be low in low-wage locations
Greater risk of problems with employee/employer relationship
Labour is a flexible resource – through multi-skilling and training
Potentially high costs of labour turnover (recruitment etc)
Labour at the heart of the production process – can help continuous improvement
Need for continuous investment in training
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