Perloff (2011)stated that economies of scale is a property of a cost function whereby theaverage cost of production falls as output expands. Diseconomies of scale isproperty of a cost function whereby the average cost of production rises whenoutput increases. (p.209) As an example if a certain company’s fixedcost is $2000 and you produce 10 units, the fixed cost per unit is $200(2000/10=200). But if you produce 50 units, the cost per unit will be $40(2000/50=40).
There is always possibility to save money by obtaining discountsfor purchases of raw resources used in production. Also costs may be reducedbecause the increase in volume may justify acquiring specialized equipment andspecialized labor that can lead to more efficiency. In addition we can notethat the benefit of economies of scale will not go on forever, eventuallyproduction will reach a pint where cost per unit increases as production volumeincreases this is called diseconomies of scale. JohnPanzar (1977) fund that “it is conventional wisdom that perfect competition canbe viable only if firm’s scale economies are exhausted at a level of outputthat is a small portion of the market. A monopoly firm supposedly minimizesindustry costs and is stable against entry if economies of scale are importantand unexhausted at the full extent of the market.
” (p.481) Stigler’s(1958) study shows:The theory of economies of scale is therelationship between the scale of use of a chosen combination of all productiveservices and the rate of output of the enterprise. In its formulation thistheory is a crucial element of the economic theory of social organization as itunderlines each and every question of market role and organization ofgovernmental control over economic life. If someone asks himself how an economywould be organized if every economic activity were prohibitively inefficientupon alternately a small scale and a large scale, and the answer will convincehim that here lies a basic element of the theory of economic organization. (p.54)Stigler(1958) also says that: This theory has slacked along for a century,collecting large pieces of a good reasoning and small chunks of experimentalevidence but never achieving scientific prosperity.
A large cause of its povertyis that the central concept of the theory-the firm of optimum size-has eludedconfident measurement. All economists have been ignorant of the optimum size offirm in almost every industry all of the time. This ignorance has been abarrier between them and the understanding of the forces which govern optimumsize. It is almost as if someone was trying to measure the values of goodswithout knowing whether the consumers who ate them continued to live. The mainthesis of this paper is that the determination of the optimum size is notdifficult if someone formalizes the logic that sensible men have alwaysemployed to judge efficient size. This technique which is as well called thesurvivor technique, reveals the optimum size in terms of private costs- that is,in terms of the environment in which the enterprise finds itself.
(p.54)According to Neil A. Doherty (1981): The possible existence of scale economies inthe provision of insurance is of particular concern to those who are interestedin the regulation of the industry. Some examples illustrate the potentialpolicy significance. At first all the rate filings made by small and largeinsurers might be considered differently in the face of significant scaleeconomies since this would influence the regulator’s target profit or level.
Second of all, scale economies might be of consequence in measuring the welfareeffects of proposed mergers and existing monopoly. Third, the use of constantsolvency rations to assess financial soundness may be inappropriate if thetotal cost functions are non-proportional. The shape of cost functions is alsoimportant to managers, in assessing policy options and to investors estimatingearning potential for firms facing natural growth or growth by merger andacquisition. Also some studies of insurance cost functions have addresseddirectly the issue of scale economies. (p. 390)The firm’s long run average cost shows what ishappening to average cost when the firm expands, and is at a tangent to theseries of short run average cost curves. Each short run average cost curverelates to a separate stage or phase of expansion. Recoursesused:Perloff,J.
(2011). Microeconomics w/mylab. Place of publication notidentified: Pearson Education.
Panzar, J.C., & Willig, R. D. (1977).
Economies of Scale in Multi-OutputProduction. The Quarterly Journal of Economics,91(3), 481.doi:10.2307/1885979Stigler,G. J. (1958). The Economies of Scale.
The Journal of Law andEconomics,1, 54-71. doi:10.1086/466541Doherty,N. A.
(1981). The Measurement of Output and Economies of Scale inProperty-Liability Insurance. The Journal of Risk and Insurance,48(3),390. doi:10.2307/252719