Market Structures, Costs and Revenue: Question 4

Worked solution

Part (a): Ranges of economies and diseconomies of scale

Reading down the LRAC row: $0.25, $0.20, $0.17, $0.17, $0.19, $0.23 for outputs of 10, 20, 30, 40, 50 and 60 thousand loaves.

• LRAC falls as output rises from 10,000 to 30,000 loaves per month ($0.25 $\to$ $0.20 $\to$ $0.17): this is the range of economies of scale.
• LRAC rises as output rises from 40,000 to 60,000 loaves per month ($0.17 $\to$ $0.19 $\to$ $0.23): this is the range of diseconomies of scale.

Part (b): Minimum efficient scale

Minimum efficient scale is the lowest level of output at which a firm first achieves the minimum point on its long-run average cost curve, the smallest plant size needed to produce at the lowest possible average cost.

In the table, LRAC reaches its lowest value of $0.17 per loaf at both 30,000 and 40,000 loaves per month. Since minimum efficient scale is defined as the lowest such output, BrightBake’s minimum efficient scale is 30,000 loaves per month.

Part (c): Why average cost falls from 10,000 to 30,000 loaves

Internal economies of scale (available to BrightBake alone, because of its own increasing size): a larger plant allows BrightBake to install a bigger, more efficient oven and other large pieces of equipment. Such equipment is often indivisible, it costs roughly the same to buy and run whether it bakes a small or a large batch, so spreading this fixed cost over a much larger number of loaves lowers the average cost per loaf.

External economies of scale (available to every firm in the baking industry, because the whole industry has grown, not just BrightBake): as more bakeries operate in the area, specialist input suppliers (for example, flour millers dealing in bulk) and a larger pool of workers already trained in bakery skills may become established locally. This lowers the cost of key inputs for every firm in the industry, including BrightBake, without BrightBake having to do anything itself.

Part (d): Why average cost might rise beyond 40,000 loaves

Beyond 40,000 loaves per month, BrightBake’s operation may become so large and complex that it suffers from diseconomies of scale, most commonly caused by management and coordination problems. As the business grows, there are more layers of management, more staff, and more decisions to communicate accurately across the organisation; this can lead to slower decision-making, breakdowns in communication between departments, and reduced managerial control over day-to-day efficiency and quality. All of which raise the average cost of producing each loaf, even though the physical scale of production has increased.

Final answers

• (a) Economies of scale from 10,000 to 30,000 loaves per month; diseconomies of scale from 40,000 to 60,000 loaves per month
• (b) Minimum efficient scale $=$ 30,000 loaves per month (the lowest output at which LRAC first reaches its minimum of $0.17)
• (c) Internal: spreading the fixed cost of large, indivisible equipment over more output; external: cheaper specialist inputs/labour as the whole local industry grows
• (d) Management and coordination problems (communication difficulties, slower decision-making) as the organisation becomes very large