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Large Firms vs. Small Firms: Average Costs of Production

Discuss whether a large firm will always have lower average costs of production than a small one.

Category:

Market Structures and Competition

Frequently asked question

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Answer

Evaluate the validity and reliability of economic data.

Whether a large firm will always have lower average costs of production than a small one depends on various factors. Let's discuss both sides of the argument:
Reasons why a large firm might have lower average costs:
➡️1. Economies of scale: Large firms can benefit from economies of scale, which refers to the cost advantages that arise when production is increased. They can achieve purchasing economies by buying inputs in bulk at discounted prices. Additionally, they can invest in large-scale capital equipment, which may be more cost-efficient. These factors can lead to lower average costs of production for large firms.
➡️2. Specialization and expertise: Large firms can afford to employ specialists and professionals across different areas of their operations. They can have dedicated research and development departments, allowing them to innovate and develop new products more effectively. This expertise can contribute to cost savings and efficiency, lowering average costs.
➡️3. Financial advantages: Large firms often have better access to financial resources, allowing them to borrow at lower interest rates and invest in productive assets. This can reduce their financial costs and, in turn, lower their average costs of production.
Reasons why a large firm might not always have lower average costs:
➡️1. Diseconomies of scale: Large firms may encounter diseconomies of scale, which occur when the efficiency gains from increasing production diminish or reverse. As firms grow larger, communication and coordination challenges may arise, leading to inefficiencies and higher average costs. Poor management practices and industrial relations issues can also contribute to diseconomies of scale.
➡️2. Opportunity cost: Large firms may face opportunity costs when allocating resources. They may need to divert resources away from producing consumer goods or exploring new markets, which can impact their average costs.
➡️3. Tax and government support: Large firms may face higher rates of taxation, such as corporation tax, which can add to their average costs. Additionally, large firms may receive less government support, such as subsidies, compared to smaller firms.
➡️4. Short-term effects: In the short run, the expansion of a large firm may lead to disruptions and adjustments that temporarily increase costs. This can affect average costs until the firm reaches a new equilibrium.
➡️5. Lower living standards: Large firms' cost-cutting strategies, such as outsourcing to lower-cost countries, may contribute to lower living standards for workers in the short term.
In conclusion, while large firms can benefit from economies of scale and other advantages, there are also potential drawbacks that can impact their average costs of production. The presence of economies or diseconomies of scale depends on various internal and external factors, and it is not universally guaranteed that a large firm will always have lower average costs compared to a small one.

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I. 🍃Introduction
- Definition of economies of scale
- Importance of understanding the advantages and disadvantages of economies of scale

II. Advantages of economies of scale
- Purchasing/buying economies
- Technical economies
- Managerial economies
- Selling economies
- Financial economies
- Research and development economies
- Spreading fixed costs over high output
- Access to cheap labor abroad

III. Disadvantages of economies of scale
- Diseconomies of scale
- Problems managing the firm
- Poor communication
- Poor industrial relations
- Opportunity cost
- Switching resources from producing consumer goods
- Lower living standards in the short run
- Less likely to receive government support
- Higher rates of tax

IV. 👉Conclusion
- Summary of advantages and disadvantages of economies of scale
- Importance of considering both sides when making business decisions.

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Up to ➡️5 marks for why they might:
• May be able to take advantage of economies of scale - purchasing/buying economies – receiving discounts from buying in bulk -
• technical – using large scale capital equipment -
• managerial – employing specialists -
• selling – e.g. lower transport costs -
• financial – borrowing at lower interest rates -
• research and development – running a department to develop new products -
• Large firms spread fixed costs over high output, reducing AFC -
• Large firms may have access to cheap labour abroad -
Up to ➡️5 marks for why they might not:
• May experience diseconomies of scale - raising average cost -
• problems managing the firms - poor communication -
• poor industrial relations -
• involve an opportunity cost -
• may have to switch resources from producing consumer goods -
• lower living standards in the short run -
• Large firms are less likely to receive government support - in the form of a subsidy -
• Large firms may pay higher rates of tax - adding to average costs - corporation tax is progressive -

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