External Diseconomies of Scale
...at the causes of the increases in a firm’s costs. Labour is the main example. Figure 1.1 shows demand for a highly skilled profession (with a high marginal revenue product). Figure 1.1 shows that a small decrease in supply of the skilled labour (caused by derived demand for the labour’s product) causes a huge increase in price for the skilled labour. Demand for raw materials is shown in a similar way if they are scarce. A simple diagram of a firm’s costs can be used to show the long run average cost curve a business would experience in an industry where external diseconomies of scale are present. Figure 2.1 demonstrates this. Figure 2.2 shows how marginal and average costs react together when there is an increase in demand. Figure 2.1 shows that short run average costs increase over time. This means that firms in the industry will not benefit from increasing returns to scale, nor is there a minimum efficient scale for optimal costs. Figure 2.2 shows that when demand in the industry changes (a shift in average revenue and marginal revenue) marginal costs increase (because of increases in the cost to produce an extra unit of the good) and profits turn to losses (this is an extreme case, most firms would probably just experience a loss in profits) To show external diseconomies of scale under perfect competition, the industry’s demand curve shifts to the right and a new, short run price is set. Supply would shift to the right to meet the extra demand (this is because of new firms entering the market to reap the benefits of the supernormal profits experienced in the short run by firms already in the market). Unfortunately, higher costs mean supply cannot be effectively increased because of higher costs and supply does not rise in line with demand causing a long run increase in the price of the product. Figure 3.1 shows the supply and demand curve for an industry without external diseconomies of scale and figure 3.2 illustrates the changes in the industry’s supply and demand curves where external diseconomies of scale are present. Figure 3.3 shows an individual firm’s cost and revenue curves with relation to the industry’s supply and demand curve. The diagrams show that in industries where external diseconomies of scale are present, increases in demand can cause businesses to start making losses. If, under perfect competition, supernormal profits are being made as a result of this initial shift in demand then the external diseconomies of scale may cause the supernormal profits to be eliminated as more firms enter the market. The question arises in industries where external diseconomies of scale are present. Can internal economies of scale exist inside the business simultaneously? Internal economies of scale will lower the average unit costs of the business. The firms can use tactical advertising; better and more efficient machinery to get more out of scarce resources; financial economies may mean they have less interest t...