Nov 22 2010

From short to long: Economies of scale and the long-run average total cost curve

Look closely at the two cost curves below:

srATC

The curve on the left is a firm’s short-run average total cost curve. The one on the right represents a firm’s long-run average total cost curve. See the difference?

I didn’t think so. The shape of a typical firm’s short-run and long-run ATC curves may in fact be identical. But there are some very important differences to understand about the short-run costs and long-run costs faced by firms.

The Short-Run: In microeconomics, we define the short-run as the period of time over which a firm’s plant size is fixed. The only variable resource is labor and raw materials, meaning that when demand increases for a firm’s product, the firm is able to increase employee work hours, hire more workers and use existing capital more intensively, but it does not have the time to acquire new capital or expand factory size. Likewise, when demand falls for a firm’s products, it can cut back on work hours, fire workers, but cannot downsize its plants or factories.

The Long-Run: The long-run is defined as the variable-plant period. A firm can adjust the number of all its inputs: land, labor and capital. One way of thinking about the difference between the short-run and the long-run is imagining the long-run as several different short-runs spread out over a larger range of output. The graph below will illustrate this concept for you.

lrATC

When we examine the long-run ATC more closely, it becomes apparent that there are in fact lots of little short-run ATC curves along the length of the long-run curve. Each of the gray lines in the graph above represent a short-run period in which this firm opened a new factories. There are three distinct phases of this firm’s long-run ATC:

  • Economies of scale: As this firm first begins to grow and open new factories, it becomes better and better at what it is producing, is able to get more output per unit of input, and thus experiences lower and lower average total costs as it grows larger. “Scale” is a synonym for size. The bigger the firm’s size, the lower its costs of production: this is called “economies of scale”. My favorite illustration of the concept of economies of scale is to think about two shoe companies: Nike and Luigi’s Fine Italian Shoes. Nike makes shoes in giant factories in Indonesia, ships them in giant containers to all corners of the world in shipments containing 100,000 shoes each. Luigi makes shoes in his basement in Milan, has two employees, and ships shoes one at a time to customers around Europe. Who will have a lower average total cost of producing shoes? Luigi or Nike? Clearly, Nike has economies of scale, Luigi does not. If Luigi were to grow his business, chances are his average total costs would decline.
  • Constant Returns to Scale: For the firm above, economies of scale assure that the larger it becomes, the lower its average total costs get. Efficiency in production improves whether through the lower price of inputs achieved through bulk-ordering, its ability to attract and hire skilled managers, the lower per unit cost of shipping larger quantities of products, or other such benefits of being big. At a certain point, however, the benefits of getting larger begin to diminish. This firm’s tenth factory is its minimum efficient scale: The level of total output this firm must achieve to minimize its long-run average total cost. Beyond this level of production, as this firm continues to grow, it will see no further cost benefits; in other words, it will achieve constant returns to scale (size).
  • Diseconomies of scale: Why did the Mongol, the British and the Soviet empires collapse? Some historians argue it was because they became too big for their own good. When an organization (whether it’s a country or a firm) becomes TOO big, it begins to experience inefficiencies. When a firm grows so large that it has factories in all corners of the world, a dozen levels of management, and countless opportunities for corruption and miscommunication, its efficiency decreases and its average total costs begin to increase. In the 1980’s General Motor Company began to lose lots of business to smaller Japanese rivals. The outcome was the gigantic corporation broke up into smaller divisions, which then began to operate as different firms. For a while, GM remained competitive, partially because as a smaller firm, it was more efficient and able to compete on cost with its foreign rivals.

Diminishing Returns versus Economies of Scale: A common area of confusion for economics students is the difference between these two seemingly similar concepts. The difference lies in the two curves above, the short-run ATC and the long-run ATC.

  • The shape of short run costs (MC, ATC and AVC) are determined by the law of diminishing returns. Since short-run costs are determined by the productivity of the variable resource in the short-run (labor), diminishing returns assures that at first, since a firm can expect to get MORE output for additional units of labor (as fixed capital is used more efficiently) ATC declines as output increases. But beyond a certain point, diminishing returns sets in and the additional output attributable to more units of the variable resource declines. Inevitably, a firm will experience higher and higher average costs as its output continues to grow, since it’s only able to vary the amount of labor used, not capital.
  • The shape of long run ATC is determined by economies of scale (and diseconomies of scale). All resources are variable in the long-run, but lower costs cannot be guaranteed the larger a firm gets. At first, efficiency is improved as the firm grows, but at some point it becomes “too big for its own good” and costs start to rise as productivity of resources (land, labor and capital) is inhibited due to the firm’s massive size.

Discussion Questions:

  1. What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?
  2. Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?
  3. Why don’t more companies make jumbo jets?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

87 responses so far

87 Responses to “From short to long: Economies of scale and the long-run average total cost curve”

  1. tiffany_williamon 01 Dec 2010 at 12:37 pm

    What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    Why don’t more companies make jumbo jets?

    1) It means that when a firm increase its size into a very large one, it may benefit them in many ways in the beginning. However, disadvantages will start to occur after sometime. Such as, owner will start to have difficulties communicating or controlling over the employees as the firm has become to big to be handle. With the increase of output, the firm may lose its efficiency and cost begins to rise.

    Example may be the empire story we had before. As the empire begins to grow larger and larger, the emperor is not able to handle the large size of empire and there may be possibilities for the empire to collapse due to poor management.

    To set up an electricity company is very expensive indeed. There will be a need of large amount of capital to build one.It's a natural monopolies as each industry doesn't now have much competitors or there may be no competitors too. That's why they are not competitive as well.

    The cost and capital to make more jumbo jets needs a very high cost and many firms avoid taking this risk. The need of skilled labour or workers are as well needed. It will take time to find such skilled workers, and not only that. The cost for such workers are usually high as well.

  2. tiffany_williamon 01 Dec 2010 at 12:38 pm

    1) It means that when a firm increase its size into a very large one, it may benefit them in many ways in the beginning. However, disadvantages will start to occur after sometime. Such as, owner will start to have difficulties communicating or controlling over the employees as the firm has become to big to be handle. With the increase of output, the firm may lose its efficiency and cost begins to rise.

    Example may be the empire story we had before. As the empire begins to grow larger and larger, the emperor is not able to handle the large size of empire and there may be possibilities for the empire to collapse due to poor management.

    To set up an electricity company is very expensive indeed. There will be a need of large amount of capital to build one.It's a natural monopolies as each industry doesn't now have much competitors or there may be no competitors too. That's why they are not competitive as well.

    The cost and capital to make more jumbo jets needs a very high cost and many firms avoid taking this risk. The need of skilled labour or workers are as well needed. It will take time to find such skilled workers, and not only that. The cost for such workers are usually high as well.

  3. tiffany_williamon 01 Dec 2010 at 12:41 pm

    @# Huanni_Wu

    it's a very cute and good response of your 3rd question.

  4. Juan_Manuel_Arguedason 01 Dec 2010 at 12:58 pm

    @Bryan_DiLaura

    I think that your connection between the law of diminishing returns and the "two big for its own good". It makes a lot of sense.

  5. Dogan_Can_Ozcanon 02 Dec 2010 at 1:12 am

    What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    – It means a firm can be very large and can have more benefit than the other firms. But being a big firm can have many disadvantages. For example the owner of the firm can't control the workers and he/she can't handle all the works. After a while the output of the firm will increase day by day.So the firm will be bankrupt. I think an example to this is the empires in the history. I want to give the example from our history. Ottoman Empire enlarged its borders in a short time and after a while the sultan couldn't communicate with the other governors. After a while Ottoman Empire started to lose most of its lands.

    Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    -I think the most important reason is that building an electricity company is very expensive. If there were more electricity companies the money that people pay would be more.While building an electricity firm high-tech machines are required .Also lack of land makes it natural monopolistic market.

    Why don’t more companies make jumbo jets?

    -Most of the companies don't make jumbo jets because cost of production is really high and it can damage the economy of the company. To make jumbo jets the firm should have necessary requirements.

  6. Dogan_Can_Ozcanon 02 Dec 2010 at 1:18 am

    Response to tiffany_william

    The connection between big companies and the history of empires is really good. I think most of the people gave the same example to first question :)

  7. Andres_Finol_Rodriguon 02 Dec 2010 at 10:40 am

    What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    This is similar to the expression “too much of anything is bad for you.” When a firm is too big, it is hard to manage and begin to become inefficient. Being too big gives way to possibilities of corruption and miscommunications creates more inefficiencies and eventually this will cause the average total cost to increase.

    Some examples of things that have gotten so big that they’ve failed are: humans that are so tall they begin to have medical complications, the British empire as they could not control all their territories, and Microsoft as it has such a diverse consumer base and such different products that they do no have good customer support or a concentrated unit for a certain good.

    Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    It is because these companies have to be very efficient to work with these utilities. If there were various small companies, according to economies of scale, the cost would be very high, and this they would be charging the consumers a high price for these utilities.

    Why don’t more companies make jumbo jets?

    Jumbo jets are a product that would require a huge cost. To make a jumbo jet, millions of dollars are spent, and in order to decrease this, the company would have to grow, however, if there were more companies making jumbo jets, eventually the need would be satisfied and the costs would still be incredibly large.

  8. Andres_Finol_Rodriguon 02 Dec 2010 at 10:48 am

    @Juan_Manuel_Arguedas_Rodriguez

    I see your point of only having on type of power company as the prices will be low since they will probably have a low ATC, however if it gets too big it, there should be another company to step in.

  9. Susanne Robertsonon 03 Dec 2010 at 6:04 am

    1. What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    When a firm has become "too big for its own good" it is experiencing diseconomies of scale. This means that when a firm grows beyond the optimum size, the average costs of the firm will rise. This was the case with Bearing Point. The firm became too large for efficient management to control the firm and had an estimated 1 billion dollar in depts. As a result, in May 2009, BearingPoint's Japan unit was sold to PricewaterhouseCoopers.

    2. Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    Electricity as well as water, natural gas and garbage collection industries are mostly monopolistic. It would be easier for one firm to dominate the market for necessities because it would benefit from factors such as reduced average costs, having a larger share in the market and buying materials in bulk. If utility industries were more competitive and had more than one firm in the market, it would lead to higher prices for the consumer as these factors mentioned before would be canceled out.

    3. Why don’t more companies make jumbo jets?

    Jumbo jets are highly labour, capital and land intensive products. As a result, they can only be produced in the long run. Initially, it will be difficult for jumbo jet producers to enter the market as the barriers of entry are high and it will take time to produce jumbo jets up to standards of the consumer. The average total cost of the firm in the short run will be high and result in little profit, therefore many companies do not make jumbo jets as it has little benefit to them.

  10. Christian Camarilloon 03 Dec 2010 at 4:22 pm

    1. A firm can become too big when there is miscommunication, non-agreements between executives, too many locations world wide, etc. This is known as diseconomics of scale. For example, the British Empire was so big at one point that it had land in each and every time zone around the world. This led to diseconomics of scale and it eventually collapsed from its own success.

    2. Water, gas, and electricity companies are all monopolies, that is why there is only one per town. A monopoly has no competition; they are the only ones in that specific market. Economic of scale is applied to these monopolies because the companies have low production costs since there is no competition

    3. Barrier of entry is the reason why there aren’t many producers of jumbo jets. In order for you to even consider going into this type of market, you need to have a ridiculous amount of money which still isn’t everything. You need to compete against the few other companies which will destroy your company anyways.

  11. Christian Camarilloon 03 Dec 2010 at 4:24 pm

    that is very interesting Francisco, I thought that Starbucks would be sold world-wide but I guess not. It was a smart move foe them not to have business in your country because they wouldn’t get any business.

  12. Philippaon 03 Dec 2010 at 6:58 pm

    1. What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    A firm can become too big when having too many factories causes problems, experiencing diseconomies of scale. The additional factories cause inefficiency and rising average total costs. An increase in the amount of capital and land leads to an increase in costs. This could be due to inefficiencies in communication. A day to day example of this could be within a group of people trying to organize a birthday party. If there are too many people, there may be ambiguities about who is doing what. Everyone may think that someone else is bringing the cake or individuals believe they were allocated the cake-bringing job, so in the end no one brings the cake, or more than one cake is brought!

    2. Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    It wouldn’t be very effective to have two electricity companies in one town because they would obtain their electricity from the same plant. This would cost the same and therefore the two companies would have the same prices. Only one company is needed.

    3. Why don’t more companies make jumbo jets?

    The companies that make jumbo jets at the moment have taken a long time to get where they are now. They probably started as smaller companies making smaller jets. That company already has deals with the suppliers which would make it more difficult for other companies to try and compete with the original company for lower costs and therefore lower prices. All the specialized labour is also taken up by the original company e.g. engineers. Another company would have to offer the engineers a higher salary in order to bring them to their own company. All this would result in the newer company facing very high costs which would lead to low profits and therefore it would have to close down.

  13. Gökçe G&on 04 Dec 2010 at 3:18 am

    • What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    Basically;if a company is “too big for its own good” means that the company has diseconomies of scale.As the company grows so big, the management becames hard and it can go corrupt quite easily due to lack of control. It is hard to control every single worker. This lack of control can lead to increasing inefficiencies. The first company which comes to my mind is McDonald’s which decided to expand but ended up over-expanding at such a fast rate that they became “too big for their own good.” Starbucks hit a low point and shut down a good number of their cafes world-wide.

    • Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    In the special case of utilities, having competition would lead to inefficiency. They are government regulated. As the single company grows bigger, it makes the average costs lower, and for a nation-wide company, if one company controls the power then the overall wealth is higher than if there were competition as a result naturally monopoly is created.

    • Why don’t more companies make jumbo jets?

    Produce jumbo jets cost a fortune and the actual manufacturing of each jumbo jet takes a very long time. Boeing and Airbus have experienced economies of scale, and this can only happen in the long run. A new company will have not experienced economies of scale because of their short term presence. Because they do not receive the same amount of power as Boeing and Airbus, such as a large influence in the prices in the resource market, the new firms will have a high average cost and therefore their price per unit would be extremely large.

  14. Gökçe G&on 04 Dec 2010 at 3:26 am

    @Ozge_Elif_Ozer

    A good post demonstrating a good basic understanding of the theory of economies and diseconomies of scale and you are good at giving relevant examples.

  15. Dilan_Guneson 04 Dec 2010 at 8:44 pm

    • What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    It means that the firm is in diseconomies of scale. In history there were a lot of empires that perished because of having big land. When the size of empires increases it will not be a problem for the optimum quantity in economies of scale but when it turns to diseconomies of scale the empire will lose the control on the lands it has and it will be like diminishing returns.

    • Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    A natural monopoly is something about the largest supplier in an industry (the first supplier in the market), has an advantage than the other competitors. This tends to be economies of scale that are large in relation to the size of the market. For example public utilities (water services, electricity). “It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines); therefore, it is unlikely that a potential competitor would be willing to make the capital investment needed to even enter the monopolist's market.” (http://en.wikipedia.org/wiki/Natural_monopoly)

    • Why don’t more companies make jumbo jets?

    The cost of production is too high for making jumbo jets that’s why the companies don’t make it. The technological machines are too expensive. There are a small amount of companies which make jumbo jets because of the barriers to entering that industry.

  16. Dilan_Guneson 04 Dec 2010 at 8:55 pm

    Response to Cedric Uribe:

    I really like the way you explained each question with using economics terminology. The example you mentioned in the first question is giving the answer of the question in a way.

  17. Muhammet_Murat_Sekbaon 05 Dec 2010 at 10:56 pm

    • What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    Too big for its own good means that the company has diseconomies of scale. These reasons are poor communication, lack of motivation, difficulty of making useful decisions and coordination of workers due to the large size. As we understand one of the main problem is management problem. Since the company grows, the management of this company should be controlled , actually it will be really difficult. Moreover, management can go corrupt quite easily due to lack of control. We can give Ottoman empire. The empire was controlling the 3 mainland all over the world. Since, there were many county, and they were trying to control of the land in central place. It was a difficult situation and finally, they had started to fragment.

    • Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?

    Having competition between the industries would lead to inefficiency. They are controlled by the government. By the growing of the single company, it would also affect the costs and the costs would be lower. When there are large economies of scale because the biggest producer can undercut the prices of the others and drive them out . As a result the natural monopoly is created.

    • Why don’t more companies make jumbo jets?

    Since producing a jumbo jets cost a really huge amount money, and also manufacturing of each jumbo jet takes a very long time, each company can’t be successful . Around the world there are two famous jets producers which are Boeing and Airbus. These companies experienced the economies scale however, a new company will have not experienced economies of scale because of their short term presence. To sum up, since there will be high average cost and large price unit, more companies make jumbo jets.

  18. Muhammet_Murat_Sekbaon 05 Dec 2010 at 11:02 pm

    Mehmet_Mert_Suma

    A good post demonstrating a good basic understanding of the teory of economics. Your response shows a very good understanding of topic.

  19. Gloriana Gonz&aacuteon 06 Dec 2010 at 5:21 am

    That a firm becomes “too big for its own good” means that the bigger a firm gets, at the beginning it might bring many advantages, but there may come a point in which the firm gets way too big, that the advantages that i had, no longer exist. Like this article says, “When an organization becomes too big, it begins to expirience inefficies”. Example of firms that became too big for their own good are past empires that thought that by getting bigger and bigger would obtain more power and ultimetly become the best empires. But there came a point in which these empires got way too big and lost power. Some of there empires split and others simply fell.

    My hometown has only one electricity company becuase the cost of production is very high and the demand is more or less the same over an immediate time. These companies also have to comply with very stict laws and regulations that in order to server their purpose, consequently act as barries for new competitions in ths market. In Costa Rica it is a monopoly because the law only lets the government run these industries.

    Economies of scale lead this and other countries to natural monopolies because they grow to such a large size that only they can give a competitive price of the consumer.

    More companies won;t make jumbo jets because they are very expensiv and require a lot of specialization.

  20. Gloriana Gonz&aacuteon 06 Dec 2010 at 1:11 pm

    That a firm becomes “too big for its own good” means that the biger a company gets, it may bring benefits at the beginning, but at some point it will reach concequences, were the benefits no longer exist. Like this article says, “When an organization becomes too big, it begins to expirience inefficies”. This shows how a company if it gets to big, will have more conquecenes than benefits and will hurt it economy. There are some cases were a company may get bigger and obtain lots of power and become one of the best, but there is also an opportunity were they get to its maximum where they are way too big, and start lossing what they had. Some of this companies what they do is split or simply fall.

    My hometown had only one electricity company becuase the demand is more or less the same over a period of time and the cost of the production is very high. They have to follow several very strict rules in order to server for this purpose and not many companies are willing to follow these. Costa Rica can be interpreted as a monopoly because the government dicides which industries are the ones incharge.

    More companies won’t make jumbo jets because they are very expensive and require a lot of specialization. People and companies are not all willing to do this type of work.

    Response to Daniella Majluf:

    I agree with you. You have interesting ideas and we share the same idea of why more companies won’t make jumbo jets. I also enjoy how you explain well “too big for its own good”.

  21. Kansu Aydoganon 10 Dec 2010 at 3:50 pm

    1.) If a firm grows so large, then it gets hard to manage the workforce. As there will be lack of communication, there is also going to be growth of burocracy. I can give Ottoman Empire as an example of this situation.

    2.) Since it is hard to enter the sector, because there is already one company which is producing electricity, so that there won’t any profit for them and that is the reason why there is just one company producing electricity. It is not like water, natural gas and garbage because of that reason.

    3.) Since making jumbo jet is pretty expensive, small companies are not able to produce that luxury products.

  22. Ashini Jagtianion 12 Dec 2010 at 1:27 am

    Mcdonalds would be a good example. According to me the company expanded to such an extent that now in countries like India there have been problems with the food management and concerns related to health. The burger empire grew very large in the beginning and now is on the verge of a collapse- the same can be said of the American economy which build up at first during the Bush administration and now is rapidly collapsing

    Certain companies need a lot of initial investment along with some very advanced technology which is why it is tough to enter these sectors- automatically giving some companies a monopoly. In some places only the government run the electricity companies because of all the technical aspects and laws which go under these sectors

    Firstly the demand for jumbo jets is not very high. Secondly there is a barrier which restricts others companies from entering. Also the cost of producing jumbo jets is again very high along with its initial investment and technologies.

  23. Ashini Jagtianion 12 Dec 2010 at 1:29 am

    @ Huanni_Wu

    I really like the example of the Roman Empire which you used to explain the expansion of companies! It is an evidence in history which supports the rule all the more!

  24. Alehsanon 20 Feb 2011 at 10:30 pm

    1. When a company becomes too big for its own good it is a diseconomy of scale. That is to say as the total output of the firm increases the cost of producing increases increasing the ( Average cost) AC. This occurs due to a number of reasons. In the long-run, when firms grow bigger communication becomes an issue. That is to say it is more difficult to communicate business decisions and some aspects of a firm may become inefficient. Particularly if a firm is multinational, translation becomes an issue and often leads to miscommunication. However, modern technology is a great aid of reducing miscommunication. Furthermore, companies may have an inefficient management. That is to say the process of decision making is becomes slower as when the firm grows larger seeking authority becomes more difficult as the level of bureaucracy is growing. All the above factors above can combine and interact to decrease the motivation and morale of the staff and as a result decrease the productivity of a firm. Thus the average production cost of the good will rise and the firm will become too big for its own good. A relevant example is the fall of the Greek empire of Alexander the great, which was simply too big, making communication difficult, to keep it up.

    2. All of the utility industries in my home town listed, be it gas, water or electricity, are capital intensive firms. This means that it takes a large amount of fixed cost to enter the market. Thus, the risk for companies entering the market is very high and requires huge capital. This implies huge barriers to these markets that are not likely to be overcome by small firms. As a firm grows bigger, because of economies of scale, which grants advantages such as the possibility of bulk buying, the revenue of a firm increases as the cost of production is lower and the output is greater. Essentially, meaning greater profits. Thus, in the long run a company can become a “natural monopoly” because of its growth and the advantages that come with it.

    3. The barriers to start a jumbo jet production are huge s. The production of jumbo jets is capital intensive and therefore has massive fixed costs, such as the number of firms that have to be set up and the expensive raw materials that have to be obtained. Thus, a huge capital is required. Meaning that any company willing to enter the business will have to take great risks entering the market. It is particularly difficult as jumbo jets are price elastic goods making it almost impossible for starter- firms to compete with the low prices of already existing firms.

  25. Nesibe Zirzak?ranon 18 Mar 2011 at 3:28 pm

    1. What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?

    When a company becomes too big that means there is diseconomies of scale. Its cost per unit increases. There is poor communication throughout company, loss of motivation, loss of direction and coordination. Ottoman Empire is a good example of it. It had many areas of industries but it failed because it did not manage them all. It could not allocate its resources properly that lead to loss of efficieny.

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