In industrial organization, the minimum efficient scale (MES) or efficient scale of production is the lowest point where the plant (or firm) can produce such that its long run average costs are minimized. It is also the point at which the firm can achieve necessary economies of scale for it to compete effectively within the market. [1]
Economies of scale refers to the cost advantage arise from increasing amount of production. Mathematically, it is a situation in which the firm can double its output for less than doubling the cost, which brings cost advantages. Usually, economies of scale can be represented in connection with a cost-production elasticity, Ec. [2]
The cost-production elasticity equation can be rewritten to express the relationship between marginal cost and average cost.
The minimum efficient scale can be computed by equating average cost (AC) with marginal cost (MC).i.e.. The rationale behind this is that if a firm were to produce a small number of units, its average cost per unit would be high because the bulk of the costs would come from fixed costs. But if the firm produces more units, the average cost incurred per unit will be lower as the fixed costs are spread over a larger number of units; the marginal cost is below the average cost, pulling the latter down. The efficient scale of production is then reached when the average cost is at its minimum and therefore the same as the marginal cost.
The concept of minimum efficient scale is useful in determining the likely market structure of a market. For instance, if the minimum efficient scale is small relative to the overall size of the market (demand for the good), there will be a large number of firms. The firms in this market will be likely to behave in a perfectly competitive manner due to the large number of competitors. [3] However, if the minimum efficient scale can only be achieved at a significantly high levels of output relative to the overall size of the market, the number of firms will be small, the market is likely to be a oligopoly or monopoly market.
Modern cost theory and recent empirical studies [4] [5] suggest that, instead of a U-shaped curve due to the presence of diseconomies of scale, the long run average cost curve is more likely to be L-shaped. In the L-shaped cost curve, the long run cost would keep fixed with a significantly increased scale of output once the firm reaches the minimum efficient scale (MES).
However, the average cost in an L-shaped curve may further decrease even though most economies of scale have been exploited when firms achieve the MES because of technical and production economies. For instance, the firm may obtain further economies of scale from skill improvement by training the employees, decentralization in management. Secondly, repair cost and scrap rate will decrease when the firm reaches a certain size. Thirdly, improvement in the firm's vertical integration, producing by a firm itself some of the materials and equipment it needs at a lower cost for its production process instead of buying them from other firms.
In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output decreasing which causes scale increasing. At the basis of economies of scale there may be technical, statistical, organizational or related factors to the degree of market control.
In economics, profit maximization is the short run or long run process by which a firm may determine the price, input and output levels that lead to the highest profit. Neoclassical economics, currently the mainstream approach to microeconomics, usually models the firm as maximizing profit.
In economics, elasticity refers to the measurement of a percentage change of one economic variable in response to a change in another.
Economies of scope are "efficiencies formed by variety, not volume". In economics, "economies" is synonymous with cost savings and "scope" is synonymous with broadening production/services through diversified products. Economies of scope is an economic theory stating that average total cost of production decrease as a result of increasing the number of different goods produced. For example, a gas station that sells gasoline can sell soda, milk, baked goods, etc. through their customer service representatives and thus gasoline companies achieve economies of scope.
The following outline is provided as an overview of and topical guide to industrial organization:
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.
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 and in particular neoclassical economics, the marginal product or marginal physical productivity of an input is the change in output resulting from employing one more unit of a particular input, assuming that the quantities of other inputs are kept constant.
In economics, diminishing returns is the decrease in marginal (incremental) output of a production process as the amount of a single factor of production is incrementally increased, holding all other factors of production equal.
James Edward Meade, was a British economist and winner of the 1977 Nobel Memorial Prize in Economic Sciences jointly with the Swedish economist Bertil Ohlin for their "pathbreaking contribution to the theory of international trade and international capital movements".
In economics, returns to scale describe what happens to long run returns as the scale of production increases, 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 the long run linkage of the rate of increase in output (production) relative to associated increases in the inputs. In the long run, all factors of production are variable and subject to change in response to a given increase in production 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.
Marginal revenue is a central concept in microeconomics that describes the additional total revenue generated by increasing product sales by 1 unit. To derive the value of marginal revenue, it is required to examine the difference between the aggregate benefits a firm received from the quantity of a good and service produced last period and the current period with one extra unit increase in the rate of production. Marginal revenue is a fundamental tool for economic decision making within a firm's setting, together with marginal cost to be considered.
The Lerner index, formalized in 1934 by British economist of Russian origin Abba Lerner, is a measure of a firm's market power.
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.
In economics, supply is the amount of a resource that firms, producers, labourers, providers of financial assets, or other economic agents are willing and able to provide to the marketplace or directly to another agent in the marketplace. Supply can be in currency, time, raw materials, or any other scarce or valuable object that can be provided to another agent. This is often fairly abstract. For example in the case of time, supply is not transferred to one agent from another, but one agent may offer some other resource in exchange for the first spending time doing something. Supply is often plotted graphically as a supply curve, with the quantity provided plotted horizontally and the price plotted vertically.
In mathematics, the elasticity or point elasticity of a positive differentiable function f of a positive variable at point a is defined as
In economics, the marginal product of labor (MPL) is the change in output that results from employing an added unit of labor. It is a feature of the production function, and depends on the amounts of physical capital and labor already in use.
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.
A Robinson Crusoe economy is a simple framework used to study some fundamental issues in economics. It assumes an economy with one consumer, one producer and two goods. The title "Robinson Crusoe" is a reference to the 1719 novel of the same name authored by Daniel Defoe.
A monopoly price is set by a seller with market power; that is, a seller who can drive up the price by reducing the quantity he sells, as opposed to "perfect competition", under which sellers simply take the market price as given. The simplest case of market power is a monopoly, a firm that lacks any viable competition and is the sole producer of the industry's product. Because a monopoly has market power, it can set a monopoly price that is above the firm's marginal (economic) cost. Since marginal cost is the increment in total required to produce an additional unit of the product, the firm is thus able to earn positive economic profits if its fixed cost is low enough.
