Economies of scale

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As quantity of production increases from Q to Q2, the average cost of each unit decreases from C to C1. LRAC is the long run average cost Economies of scale.svg
As quantity of production increases from Q to Q2, the average cost of each unit decreases from C to C1. LRAC is the long run average cost

In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation (typically measured by amount of output produced), with cost per unit of output decreasing with increasing scale. At the basis of economies of scale there may be technical, statistical, organizational or related factors to the degree of market control.

Microeconomics branch of economics that studies the behavior of individual households and firms in making decisions on the allocation of limited resources

Microeconomics is a branch of economics that studies the behaviour of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms.

Market (economics) Mechanisms whereby supply and demand confront each other and deals are made, involving places, processes and institutions in which exchanges occur.

A market is one of the many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers. It can be said that a market is the process by which the prices of goods and services are established. Markets facilitate trade and enable the distribution and resource allocation in a society. Markets allow any trade-able item to be evaluated and priced. A market emerges more or less spontaneously or may be constructed deliberately by human interaction in order to enable the exchange of rights of services and goods. Markets generally supplant gift economies and are often held in place through rules and customs, such as a booth fee, competitive pricing, and source of goods for sale.

Contents

Economies of scale apply to a variety of organizational and business situations and at various levels, such as a production, plant or an entire enterprise. When average costs start falling as output increases, then economies of scale are occurring. Some economies of scale, such as capital cost of manufacturing facilities and friction loss of transportation and industrial equipment, have a physical or engineering basis.

Another source of scale economies is the possibility of purchasing inputs at a lower per-unit cost when they are purchased in large quantities.

The economic concept dates back to Adam Smith and the idea of obtaining larger production returns through the use of division of labor. [1] Diseconomies of scale are the opposite.

Adam Smith 18th-century Scottish moral philosopher and political economist

Adam Smith was a Scottish economist, philosopher and author as well as a moral philosopher, a pioneer of political economy and a key figure during the Scottish Enlightenment, also known as ''The Father of Economics'' or ''The Father of Capitalism''. Smith wrote two classic works, The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776). The latter, often abbreviated as The Wealth of Nations, is considered his magnum opus and the first modern work of economics. In his work, Adam Smith introduced his theory of absolute advantage.

Diseconomies of scale the forces that cause larger firms and governments to produce goods and services at increased per-unit costs

In microeconomics, diseconomies of scale are the cost disadvantages that economic actors accrue due to an increase in organizational size or in output, resulting in production of goods and services at increased per-unit costs. The concept of diseconomies of scale is the opposite of economies of scale. In business, diseconomies of scale are the features that lead to an increase in average costs as a business grows beyond a certain size.

Economies of scale often have limits, such as passing the optimum design point where costs per additional unit begin to increase. Common limits include exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry. A common limit for low cost per unit weight commodities is saturating the regional market, thus having to ship product uneconomic distances. Other limits include using energy less efficiently or having a higher defect rate.

Pulp and paper industry an industry that belongs to the secundary sector (industry) and is involved in the manufacture of paper and paperboard

The pulp and paper industry comprises companies that use wood as raw material and produce pulp, paper, paperboard and other cellulose-based products.

Large producers are usually efficient at long runs of a product grade (a commodity) and find it costly to switch grades frequently. They will therefore avoid specialty grades even though they have higher margins. Often smaller (usually older) manufacturing facilities remain viable by changing from commodity grade production to specialty products. [2] [3]

Economies of scale must be distinguished by economies stemming from an increase in the production of a given plant. When a plant is used below its optimal production capacity, increases of its degree of utilization bring about decreases in the total average cost of production. As noticed, among the others, by Nicholas Georgescu-Roegen (1966) and Nicholas Kaldor (1972) these economies cost are not economies of scale.

Productive capacity is the maximum possible output of an economy. According to the United Nations Conference on Trade and Development (UNCTAD), no agreed-upon definition of maximum output exists. UNCTAD itself proposes: "the productive resources, entrepreneurial capabilities and production linkages which together determine the capacity of a country to produce goods and services." The term may also be applied to individual resources or assets; for instance the productive capacity of an area of farmland.

Nicholas Georgescu-Roegen Mathematician, Statistician and Economist

Nicholas Georgescu-Roegen was a Romanian American mathematician, statistician and economist. He is best known today for his 1971 magnum opus The Entropy Law and the Economic Process, in which he argued that all natural resources are irreversibly degraded when put to use in economic activity. A progenitor and a paradigm founder in economics, Georgescu-Roegen's work was seminal in establishing ecological economics as an independent academic sub-discipline in economics.

Nicholas Kaldor British/Hungarian economist

Nicholas Kaldor, Baron Kaldor, born Káldor Miklós, was a Cambridge economist in the post-war period. He developed the "compensation" criteria called Kaldor–Hicks efficiency for welfare comparisons (1939), derived the cobweb model, and argued for certain regularities observable in economic growth, which are called Kaldor's growth laws. Kaldor worked alongside Gunnar Myrdal to develop the key concept Circular Cumulative Causation, a multicausal approach where the core variables and their linkages are delineated. Both Myrdal and Kaldor examine circular relationships, where the interdependencies between factors are relatively strong, and where variables interlink in the determination of major processes. Gunnar Myrdal got the concept from Knut Wicksell and developed it alongside Nicholas Kaldor when they worked together at the United Nations Economic Commission for Europe. Myrdal concentrated on the social provisioning aspect of development, while Kaldor concentrated on demand-supply relationships to the manufacturing sector. Kaldor also coined the term "convenience yield" related to commodity markets and the so-called theory of storage, which was initially developed by Holbrook Working.

Overview

The simple meaning of economies of scale is doing things more efficiently with increasing size. [4] Common sources of economies of scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function). Each of these factors reduces the long run average costs (LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to the right.

Economies of scale is a concept that may explain real-world phenomena such as patterns of international trade or the number of firms in a market. The exploitation of economies of scale helps explain why companies grow large in some industries. It is also a justification for free trade policies, since some economies of scale may require a larger market than is possible within a particular country—for example, it would not be efficient for Liechtenstein to have its own carmaker if they only sold to their local market. A lone carmaker may be profitable, but even more so if they exported cars to global markets in addition to selling to the local market. Economies of scale also play a role in a "natural monopoly". There is a distinction between two types of economies of scale: internal and external. An industry that exhibits an internal economy of scale is one where the costs of production fall when the number of firms in the industry drops, but the remaining firms increase their production to match previous levels. Conversely, an industry exhibits an external economy of scale when costs drop due to the introduction of more firms, thus allowing for more efficient use of specialized services and machinery.

The management thinker and translator of the Toyota Production System for service, Professor John Seddon, argues that attempting to create economies by increasing scale is powered by myth in the service sector. Instead, he believes that economies will come from improving the flow of a service, from the first receipt of a customer's demand to the eventual satisfaction of that demand. In trying to manage and reduce unit costs, firms often raise total costs by creating failure demand. Seddon claims that arguments for an economy of scale are a mix of (a) the plausibly obvious and (b) a little hard data, brought together to produce two broad assertions, for which there is little hard factual evidence. [5]

The determinants of economies of scale

Physical and engineering basis: economies of increased dimension

Some of the economies of scale recognized in engineering have a physical basis, such as the square-cube law, by which the surface of a vessel increases by the square of the dimensions while the volume increases by the cube. This law has a direct effect on the capital cost of such things as buildings, factories, pipelines, ships and airplanes. [6]

In structural engineering, the strength of beams increases with the cube of the thickness.

Drag loss of vehicles like aircraft or ships generally increases less than proportional with increasing cargo volume, although the physical details can be quite complicated. Therefore, making them larger usually results in less fuel consumption per ton of cargo at a given speed.

Heat losses from industrial processes vary per unit of volume for pipes, tanks and other vessels in a relationship somewhat similar to the square-cube law. [7] [8] In some productions, an increase in the size of the plant reduces average variable cost, thanks to the energy savings resulting from the lower dispersion of heat.

Economies of increased dimension are often misinterpreted because of the confusion between indivisibility and three-dimensionality of space. This confusion arises from the fact that three-dimensional production elements, such as pipes and ovens, once installed and operating, are always technically indivisible. However, the economies of scale due to the increase in size do not depend on indivisibility but exclusively on the three-dimensionality of space. Indeed, indivisibility only entails the existence of economies of scale produced by the balancing of productive capacities, considered above; or of increasing returns in te utilisation of a single plant, due to its more efficient use as the quantity produced increases. However, this latter phenomenon has nothing to do with the economies of scale which, by definition, are linked to the use of a larger plant. [9]

Economies in holding stocks and reserves

At the base of economies of scale there are also returns to scale linked to statistical factors. In fact, the greater of the number of resources involved, the smaller, in proportion, is the quantity of reserves necessary to cope with unforeseen contingencies (for instance, machine spare parts, inventories, circulating capital, etc.). [10]

Transaction economies

A larger scale generally determines greater bargaining power over input prices and therefore benefits from pecuniary economies in terms of purchasing raw materials and intermediate goods compared to companies that make orders for smaller amounts. In this case we speak of pecuniary economies, to highlight the fact that nothing changes from the "physical" point of view of the returns to scale. Furthermore, supply contracts entail fixed costs which lead to decreasing average costs if the scale of production increases. [11]

Economies deriving from the balancing of production capacity

Economies of productive capacity balancing derives from the possibility that a larger scale of production involves a more efficient use of the production capacities of the individual phases of the production process. If the inputs are indivisible and complementary, a small scale may be subject to idle times or to the underutilization of the productive capacity of some sub-processes. A higher production scale can make the different production capacities compatible. The reduction in machinery idle times is crucial in the case of a high cost of machinery. [12]

Economies resulting from the division of labour and the use of superior techniques

A larger scale allows for a more efficient division of labour. The economies of division of labour derive from the increase in production speed, from the possibility of using specialized personnel and adopting more efficient techniques. An increase in the division of labour inevitably leads to changes in the quality of inputs and outputs. [13]

Managerial Economics

Many administrative and organizational activities are mostly cognitive and, therefore, largely independent of the scale of production. [14] When the size of the company and the division of labour increase, there are a number of advantages due to the possibility of making organizational management more effective and perfecting accounting and control techniques. [15] Furthermore, the procedures and routines that turned out to be the best can be reproduced by managers at different times and places.

Learning and growth economies

Learning and growth economies are at the base of dynamic economies of scale, associated with the process of growth of the scale dimension and not to the dimension of scale per se. Learning by doing implies improvements in the ability to perform and promotes the introduction of incremental innovations with a progressive lowering of average costs. [16] Learning economies are directly proportional to the cumulative production (experience curve). Growth economies occur when a company acquires an advantage by increasing its size. These economies are due to the presence of some resource or competence that is not fully utilized, or to the existence of specific market positions that create a differential advantage in expanding the size of the firms. That growth economies disappear once the scale size expansion process is completed. For example, a company that owns a supermarket chain benefits from an economy of growth if, opening a new supermarket, it gets an increase in the price of the land it owns around the new supermarket. The sale of these lands to economic operators, who wish to open shops near the supermarket, allows the company in question to make a profit, making a profit on the revaluation of the value of building land. [17]

Capital and operating cost

Overall costs of capital projects are known to be subject to economies of scale. A crude estimate is that if the capital cost for a given sized piece of equipment is known, changing the size will change the capital cost by the 0.6 power of the capacity ratio (the point six power rule). [18] [19]

In estimating capital cost, it typically requires an insignificant amount of labor, and possibly not much more in materials, to install a larger capacity electrical wire or pipe having significantly greater capacity. [20]

The cost of a unit of capacity of many types of equipment, such as electric motors, centrifugal pumps, diesel and gasoline engines, decreases as size increases. Also, the efficiency increases with size. [21]

Crew size and other operating costs for ships, trains and airplanes

Operating crew size for ships, airplanes, trains, etc., does not increase in direct proportion to capacity. [22] (Operating crew consists of pilots, co-pilots, navigators, etc. and does not include passenger service personnel.) Many aircraft models were significantly lengthened or "stretched" to increase payload. [23]

Many manufacturing facilities, especially those making bulk materials like chemicals, refined petroleum products, cement and paper, have labor requirements that are not greatly influenced by changes in plant capacity. This is because labor requirements of automated processes tend to be based on the complexity of the operation rather than production rate, and many manufacturing facilities have nearly the same basic number of processing steps and pieces of equipment, regardless of production capacity.

Economical use of byproducts

Karl Marx noted that large scale manufacturing allowed economical use of products that would otherwise be waste. [24] Marx cited the chemical industry as an example, which today along with petrochemicals, remains highly dependent on turning various residual reactant streams into salable products. In the pulp and paper industry it is economical to burn bark and fine wood particles to produce process steam and to recover the spent pulping chemicals for conversion back to a usable form.

Economies of scale and returns to scale

Economies of scale is related to and can easily be confused with the theoretical economic notion of returns to scale. Where economies of scale refer to a firm's costs, returns to scale describe the relationship between inputs and outputs in a long-run (all inputs variable) production function. A production function has constant returns to scale if increasing all inputs by some proportion results in output increasing by that same proportion. Returns are decreasing if, say, doubling inputs results in less than double the output, and increasing if more than double the output. If a mathematical function is used to represent the production function, and if that production function is homogeneous, returns to scale are represented by the degree of homogeneity of the function. Homogeneous production functions with constant returns to scale are first degree homogeneous, increasing returns to scale are represented by degrees of homogeneity greater than one, and decreasing returns to scale by degrees of homogeneity less than one.

If the firm is a perfect competitor in all input markets, and thus the per-unit prices of all its inputs are unaffected by how much of the inputs the firm purchases, then it can be shown that at a particular level of output, the firm has economies of scale if and only if it has increasing returns to scale, has diseconomies of scale if and only if it has decreasing returns to scale, and has neither economies nor diseconomies of scale if it has constant returns to scale. [25] [26] [27] In this case, with perfect competition in the output market the long-run equilibrium will involve all firms operating at the minimum point of their long-run average cost curves (i.e., at the borderline between economies and diseconomies of scale).

If, however, the firm is not a perfect competitor in the input markets, then the above conclusions are modified. For example, if there are increasing returns to scale in some range of output levels, but the firm is so big in one or more input markets that increasing its purchases of an input drives up the input's per-unit cost, then the firm could have diseconomies of scale in that range of output levels. Conversely, if the firm is able to get bulk discounts of an input, then it could have economies of scale in some range of output levels even if it has decreasing returns in production in that output range.

In essence, returns to scale refer to the variation in the relationship between inputs and output. This relationship is therefore expressed in "physical" terms. But when talking about economies of scale, the relation taken into consideration is that between the average production cost and the dimension of scale. Economies of scale therefore are affected by variations in input prices. If input prices remain the same as their quantities purchased by the firm increase, the notions of increasing returns to scale and economies of scale can be considered equivalent. However, if input prices vary in relation to their quantities purchased by the company, it is necessary to distinguish between returns to scale and economies of scale. The concept of economies of scale is more general than that of returns to scale since it includes the possibility of changes in the price of inputs when the quantity purchased of inputs varies with changes in the scale of production. [28]

The literature assumed that due to the competitive nature of reverse auctions, and in order to compensate for lower prices and lower margins, suppliers seek higher volumes to maintain or increase the total revenue. Buyers, in turn, benefit from the lower transaction costs and economies of scale that result from larger volumes. In part as a result, numerous studies have indicated that the procurement volume must be sufficiently high to provide sufficient profits to attract enough suppliers, and provide buyers with enough savings to cover their additional costs. [29]

However, surprisingly enough, Shalev and Asbjornse found, in their research based on 139 reverse auctions conducted in the public sector by public sector buyers, that the higher auction volume, or economies of scale, did not lead to better success of the auction. They found that auction volume did not correlate with competition, nor with the number of bidders, suggesting that auction volume does not promote additional competition. They noted, however, that their data included a wide range of products, and the degree of competition in each market varied significantly, and offer that further research on this issue should be conducted to determine whether these findings remain the same when purchasing the same product for both small and high volumes. Keeping competitive factors constant, increasing auction volume may further increase competition. [29]

Economies of scale in the history of economic analysis

Economies of scale in classical economists

The first systematic analysis of the advantages of the division of labour capable of generating economies of scale, both in a static and dynamic sense, was that contained in the famous First Book of Wealth of Nations (1776) by Adam Smith, generally considered the founder of political economy as an autonomous discipline.

John Stuart Mill, in Chapter IX of the First Book of his Principles, referring to the work of Charles Babbage (On the economics of machines and manufactories), widely analyses the relationships between increasing returns and scale of production all inside the production unit.

The economies of scale in Marx and Distributional consequences

In “Das Kapital” (1867), Karl Marx, referring to Charles Babbage, extensively analyses economies of scale and concludes that they are one of the factors underlying the ever-increasing concentration of capital. Marx observes that in the capitalist system the technical conditions of the work process are continuously revolutionized in order to increase the surplus by improving the productive force of work. According to Marx, with the cooperation of many workers brings about an economy in the use of the means of production and an increase in productivity due to the increase in the division of labour. Furthermore, the increase in the size of the machinery allows significant savings in construction, installation and operation costs. The tendency to exploit economies of scale entails a continuous increase in the volume of production which, in turn, requires a constant expansion of the size of the market. [30] However, if the market does not expand at the same rate as production increases, overproduction crises can occur. According to Marx the capitalist system is therefore characterized by two tendencies, connected to economies of scale: towards a growing concentration and towards economic crises due to overproduction. [31]

In his 1844 Economic and Philosophic Manuscripts , Karl Marx observes that economies of scale have historically been associated with an increasing concentration of private wealth and have been used to justify such concentration. Marx points out that concentrated private ownership of large-scale economic enterprises is a historically contingent fact, and not essential to the nature of such enterprises. In the case of agriculture, for example, Marx calls attention to the sophistical nature of the arguments used to justify the system of concentrated ownership of land:

As for large landed property, its defenders have always sophistically identified the economic advantages offered by large-scale agriculture with large-scale landed property, as if it were not precisely as a result of the abolition of property that this advantage, for one thing, received its greatest possible extension, and, for another, only then would be of social benefit. [32]

Instead of concentrated private ownership of land, Marx recommends that economies of scale should instead be realized by associations:

Association, applied to land, shares the economic advantage of large-scale landed property, and first brings to realization the original tendency inherent in land-division, namely, equality. In the same way association re-establishes, now on a rational basis, no longer mediated by serfdom, overlordship and the silly mysticism of property, the intimate ties of man with the earth, for the earth ceases to be an object of huckstering, and through free labor and free enjoyment becomes once more a true personal property of man. [32]

Economies of scale in Marshall

Alfred Marshall notes that "some, among whom Cournot himself", have considered "the internal economies [...] apparently without noticing that their premises lead inevitably to the conclusion that, whatever firm first gets a good start will obtain a monopoly of the whole business of its trade … ". [33] Marshall believes that there are factors that limit this trend toward monopoly, and in particular:

Sraffa’s critique

Piero Sraffa observes that Marshall, in order to justify the operation of the law of increasing returns without it coming into conflict with the hypothesis of free competition, tended to highlight the advantages of external economies linked to an increase in the production of an entire sector of activity. However, “those economies which are external from the point of view of the individual firm, but internal as regards the industry in its aggregate, constitute precisely the class which is most seldom to be met with”. “In any case - Sraffa notes – in so far as external economies of the kind in question exist, they are not linked to be called forth by small increases in production”, as required by the marginalist theory of price. [35] Sraffa points out that, in the equilibrium theory of the individual industries, the presence of external economies cannot play an important role because this theory is based on marginal changes in the quantities produced.

Sraffa concludes that, if the hypothesis of perfect competition is maintained, economies of scale should be excluded. He then suggests the possibility of abandoning the assumption of free competition to address the study of firms that have their own particular market. [36] This stimulated a whole series of studies on the cases of imperfect competition in Cambridge. However, in the succeeding years Sraffa will follow a different path of research that will bring him to write and publish his main work Production of commodities by means of commodities (Sraffa, 1960). In this book Sraffa determines relative prices assuming no changes in output, so that no question arises as to the variation or constancy of returns.

Economies of scale and the tendency towards monopoly: ‘Cournot's dilemma’

It has been noted that in many industrial sectors there are numerous companies with different sizes and organizational structures, despite the presence of significant economies of scale. This contradiction, between the empirical evidence and the logical incompatibility between economies of scale and competition, has been called the ‘Cournot dilemma’. [37] As Mario Morroni observes, Cournot's dilemma appears to be unsolvable if we only consider the effects of economies of scale on the dimension of scale. [38] If, on the other hand, the analysis is expanded, including the aspects concerning the development of knowledge and the organization of transactions, it is possible to conclude that economies of scale do not always lead to monopoly. In fact, the competitive advantages deriving from the development of the firm's capabilities and from the management of transactions with suppliers and customers can counterbalance those provided by the scale, thus counteracting the tendency towards a monopoly inherent in economies of scale. In other words, the heterogeneity of the organizational forms and of the size of the companies operating in a sector of activity can be determined by factors regarding the quality of the products, the production flexibility, the contractual methods, the learning opportunities, the heterogeneity of preferences of customers who express a differentiated demand with respect to the quality of the product, and assistance before and after the sale. Very different organizational forms can therefore co-exist in the same sector of activity, even in the presence of economies of scale, such as, for example, flexible production on a large scale, small-scale flexible production, mass production, industrial production based on rigid technologies associated with flexible organizational systems and traditional artisan production. The considerations regarding economies of scale are therefore important, but not sufficient to explain the size of the company and the market structure. It is also necessary to take into account the factors linked to the development of capabilities and the management of transaction costs. [38]

See also

Notes

  1. O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, NJ: Pearson Prentice Hall. p. 157. ISBN   978-0-13-063085-8.
  2. Manufacture of specialty grades by small scale producers is a common practice in steel, paper and many commodity industries today. See various industry trade publications.
  3. Landes, David. S. (1969). The Unbound Prometheus: Technological Change and Industrial Development in Western Europe from 1750 to the Present. Cambridge, New York: Press Syndicate of the University of Cambridge. p. 470. ISBN   978-0-521-09418-4<Landes describes the problem of new steel mills in late 19th century Britain being too large for the market and unable to economically produce short production runs of specialty grades. The old mills had another advantage in that they were fully amortized.>
  4. Chandler Jr., Alfred D. (1993). The Visible Hand: The Management Revolution in American Business. Belknap Press of Harvard University Press. p. 236. ISBN   978-0674940529<Chandler uses the example of high turn over in distribution>
  5. "Why do we believe in economy of scale? : Professor John Seddon, managing director Vanguard" (PDF). S3.amazonaws.com. July 2010. Retrieved 23 December 2017.
  6. See various estimating guides, such as Means. Also see various engineering economics texts related to plant design and construction, etc.
  7. The relationship is rather complex. See engineering texts on heat transfer.
  8. Robinson (1931, pp. 22-3); Scherer (1980, pp. 82-3); Pratten (1991, pp. 16-17).
  9. Morroni (2006, pp. 169-70).
  10. Baumol (1961, p. 1).
  11. Morroni (2006, pp. 170-1).
  12. Morroni (2006, p. 166).
  13. Smith (1776); Pratten (1991, pp. 7, 17-8). On the relationship between built-in technical change and scale growth, see Evangelista (1999, chapter 4).
  14. Demsetz (1995, pp. 11, 31-2) shows how these economies of scale in the acquisition of specialized knowledge play an essential role in the existence of the company.
  15. Scherer (1980, p. 86); cf. Penrose (1959, pp. 92 ff.); Demsetz (1995, pp. 31-2).
  16. Rosenberg (1982); Levin et al. (1988); Scherer (2000, p. 22).
  17. Penrose (1959, pp. 99-101); Morroni (2006, p. 172).
  18. [[In microeconomics, economies of scale are the cost advantages that enterprises obtain due to size, output, or scale of operation, with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output. Often operational efficiency is also greater with increasing scale, leading to lower variable cost as well. Economies of scale apply to a variety of organizational and business situations and at various levels, such as a business or manufacturing unit, plant or an entire enterprise. For example, a large manufacturing facility would be expected to have a lower cost per unit of output than a smaller facility, all other factors being equal, while a company with many facilities should have a cost advantage over a competitor with fewer. Some economies|Moore, Fredrick T.]] (May 1959). "Economies of Scale: Some Statistical Evidence" (PDF). Quarterly Journal of Economics . 73 (2): 232–245. doi:10.2307/1883722. JSTOR   1883722.
  19. In practice, capital cost estimates are prepared from specifications, budget grade vendor pricing for equipment, general arrangement drawings and materials take-offs from the drawings. This information is then used in cost formulas to arrive at a final detailed estimate.
  20. See various estimating guides that publish tables of tasks commonly encountered in building trades with estimates of labor hours and costs per hour for the trade, often with regional pricing.
  21. See various engineering handbooks and manufacturers data.
  22. Rosenberg, Nathan (1982). Inside the Black Box: Technology and Economics. Cambridge, New York: Cambridge University Press. p. 63. ISBN   978-0-521-27367-1<Specifically mentions ships.>
  23. Rosenberg 1982 , pp. 127–128
  24. Rosenberg 1982
  25. Gelles, Gregory M.; Mitchell, Douglas W. (1996). "Returns to Scale and Economies of Scale: Further Observations". Journal of Economic Education. 27 (3): 259–261. doi:10.1080/00220485.1996.10844915. JSTOR   1183297.
  26. Frisch, R. (1965). Theory of Production. Dordrecht: D. Reidel.
  27. Ferguson, C. E. (1969). The Neoclassical Theory of Production & Distribution. London: Cambridge University Press. ISBN   978-0-521-07453-7.
  28. Morroni (1992, p. 142; 2006, pp. 164-5).
  29. 1 2 Shalev, Moshe Eitan; Asbjornsen, Stee (2010). "Electronic Reverse Auctions and the Public Sector – Factors of Success". Journal of Public Procurement. 10 (3): 428–452. SSRN   1727409 .
  30. Marx (1867 in 1990, pp. 432-42, 469).
  31. Marx (1894 in 1981, pp. 172, 288, 360-5).
  32. 1 2 Karl Marx, Economic and Philosophic Manuscripts of 1844 , M. Milligan, trans. (1988), p. 65–66
  33. Marshall (1890 in 1990, p. 380, note 1); cf. Cournot (1838 in 1938, pp. 96 ff.).
  34. Marshall (1890 in 1990, pp. 232-8, 378-80).
  35. Sraffa (1926 in 2003, p. 49); cf. Sraffa (1925).
  36. Sraffa (1926 in 2003, p. 58).
  37. Arrow (1979, p. 156).
  38. 1 2 Morroni (2006, pp. 253-6).

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In economics, marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit; that is, it is the cost of producing one more unit of a good. Intuitively, marginal cost at each level of production includes the cost of any additional inputs required to produce the next unit. At each level of production and time period being considered, marginal costs include all costs that vary with the level of production, whereas other costs that do not vary with production are fixed and thus have no marginal cost. For example, the marginal cost of producing an automobile will generally include the costs of labor and parts needed for the additional automobile but not the fixed costs of the factory that have already been incurred. In practice, marginal analysis is segregated into short and long-run cases, so that, over the long run, all costs become marginal. Where there are economies of scale, prices set at marginal cost will fail to cover total costs, thus requiring a subsidy. Marginal cost pricing is not a matter of merely lowering the general level of prices with the aid of a subsidy; with or without subsidy it calls for a drastic restructuring of pricing practices, with opportunities for very substantial improvements in efficiency at critical points.

Production function physical output of a production process to physical inputs or factors of production

In economics, a production function gives the technological relation between quantities of physical inputs and quantities of output of goods. The production function is one of the key concepts of mainstream neoclassical theories, used to define marginal product and to distinguish allocative efficiency, a key focus of economics. One important purpose of the production function is to address allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors, while abstracting away from the technological problems of achieving technical efficiency, as an engineer or professional manager might understand it.

In economics, average cost or unit cost is equal to total cost (TC) divided by the number of units of a good produced :

In economics, diminishing returns is the decrease in the marginal (incremental) output of a production process as the amount of a single factor of production is incrementally increased, while the amounts of all other factors of production stay constant.

In economics, returns to scale and economies of scale are related but different concepts that describe what happens as the scale of production increases in the long run, when all input levels including physical capital usage are variable. The concept of returns to scale arises in the context of a firm's production function. It explains behavior of the rate of increase in output (production) relative to the associated increase in the inputs in the long run. In the long run all factors of production are variable and subject to change due to a given increase in size (scale). While economies of scale show the effect of an increased output level on unit costs, returns to scale focus only on the relation between input and output quantities.

The theory of the firm consists of a number of economic theories that explain and predict the nature of the firm, company, or corporation, including its existence, behaviour, structure, and relationship to the market.

In economics, a cost curve is a graph of the costs of production as a function of total quantity produced. In a free market economy, productively efficient firms optimize their production process by minimizing cost consistent with each possible level of production, and the result is a cost curve. profit maximizing firms use cost curves to decide output quantities. There are various types of cost curves, all related to each other, including total and average cost curves; marginal cost curves, which are equal to the differential of the total cost curves; and variable cost curves. Some are applicable to the short run, others to the long run.

Productive and unproductive labour are concepts that were used in classical political economy mainly in the 18th and 19th centuries, which survive today to some extent in modern management discussions, economic sociology and Marxist or Marxian economic analysis. The concepts strongly influenced the construction of national accounts in the Soviet Union and other Soviet-type societies.

In economics the long run is a theoretical concept in which all markets are in equilibrium, and all prices and quantities have fully adjusted and are in equilibrium. The long run contrasts with the short run, in which there are some constraints and markets are not fully in equilibrium.

In economics, gains from trade are the net benefits to economic agents from being allowed an increase in voluntary trading with each other. In technical terms, they are the increase of consumer surplus plus producer surplus from lower tariffs or otherwise liberalizing trade.

Ricardian economics

Ricardian economics are the economic theories of David Ricardo, an English political economist born in 1772 who made a fortune as a stockbroker and loan broker. At the age of 27, he read An Inquiry into the Nature and Causes of Wealth of Nations by Adam Smith and was energized by the theories of economics.

Socially optimal firm size

The socially optimal firm size is the size for a company in a given industry at a given time which results in the lowest production costs per unit of output.

The Cambridge capital controversy, sometimes called "the capital controversy" or "the two Cambridges debate", was a dispute between proponents of two differing theoretical and mathematical positions in economics that started in the 1950s and lasted well into the 1960s. The debate concerned the nature and role of capital goods and a critique of the neoclassical vision of aggregate production and distribution. The name arises from the location of the principals involved in the controversy: the debate was largely between economists such as Joan Robinson and Piero Sraffa at the University of Cambridge in England and economists such as Paul Samuelson and Robert Solow at the Massachusetts Institute of Technology, in Cambridge, Massachusetts.

Surplus value is a central concept in Karl Marx's critique of political economy. "Surplus value" is a translation of the German word "Mehrwert", which simply means value added, and is cognate to English "more worth". Surplus-value is the difference between the amount raised through a sale of a product and the amount it cost to the owner of that product to manufacture it: i.e. the amount raised through sale of the product minus the cost of the materials, plant and labour power. Conventionally, value-added is equal to the sum of gross wage income and gross profit income. However, Marx uses the term Mehrwert to describe the yield, profit or return on production capital invested, i.e. the amount of the increase in the value of capital. Hence, Marx's use of Mehrwert has always been translated as "surplus value", distinguishing it from "value-added". According to Marx's theory, surplus value is equal to the new value created by workers in excess of their own labor-cost, which is appropriated by the capitalist as profit when products are sold.

Microeconomics is the study of the behaviour of individuals and small impacting organisations in making decisions on the allocation of limited resources. The modern field of microeconomics arose as an effort of neoclassical economics school of thought to put economic ideas into mathematical mode.

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