Total Cost Box 2.

1 FC, VC, & Shut Down Decision

‹ C= 200 + 45Q ‹ What was the error in the decision to shut
» FC? down production of blue pens?
» MC?
– Allocate overhead based on output; ideal for
accounting purposes, but for production decisions?
‹ C= 100 + 50Q + 25Q2 + 3Q3
» FC?

» MC?

Economies of Scale (graph) Economies (cont.)

Economies of scale and seller concentration
‹ E.g. MES of a plant that produces artificial sweetener
aspartame is equal to 2,500 metric tons
‹ This is equal to 1/3 of world demand in the late 1980s
‹ T t l sales
Total l in
i Canada
C d in i 1989 were 359 tons
t
‹ Can a plant be constructed whose capacity is below the MES
to serve the needs of a small country like Canada?
Economies of Scale Economies of Scale
¾Scale Economy Index
‹ Sources of Economies of Scale

¾S(q) = AC(q) / MC(q)

¾S(q) = 1 constant returns to scale

¾S(q) > 1 economies of scale
¾S(q) < 1 diseconomies of scale

Economies of Scale v Scope Economies of Scope

‹ E. of Scale ‹ TC(QX, QY) < TC(QX, 0) + TC(0, QY)
– Cost savings from

‹ TC(QX, QY) – TC (0, QY)

< TC(QX, 0) - TC(0, 0)
‹ E. of Scope
– Cost savings from
Economies (cont.) Economies (cont.)
¾ Diseconomies of
¾Multi
Multi--plant economies of Scope ¾ Scale

¾ Scope

How IO economists infer industry

cost structure from firm decisions: Economies of Density: Wal-Mart
Acoustic and electric guitars ‹ Tom Holmes, UMN “Diffusion of Wal-Mart
¾High end producers concentrate production on one type and Economies of Density” (July 2009)
of guitar and low end producers manufacture both types
of guitars. What does this imply about economies of ‹ http://www.econ.umn.edu/~holmes/research.ht
scope?? mll (See
(S movie i off W
Wal-Mart
l M t store
t openings.)
i )
‹ What costs can a retailer reduce by locating its
stores close together?
Flutes and piccolos
¾ Often both produced by same firm, but not in large
quantities. What does this imply about economies of
scale and scope?