ECO204 Week 3 Discussion 2 Long-Run Average Cost and Economies of Scale

Class,

How can the long-run average cost (LRAC) curve be derived from the short-run average total cost (SRATC) curve?

          When calculating inputs and outputs for the short run, there are certain fixed inputs and variable inputs, the long run has no fixed inputs and is subsequently all calculated on variables.  The short run takes fixed costs and variable costs and calculates total cost for a given amount of output performance.  Using this calculation, the short run makes a cost and production curve for the lowest level of essentially breaking even before increasing output, the LRAC takes their variable input and output and correlates it to the short term curves, by finding the median point since the cost and production short curves run tangent, they can find the optimal focal point (sweet spot) for their baseline of what their inputs and outputs would be to calculate total cost for all variable inputs (Amacher & Pate, 2013, Ch. 8.2-8.3).

Describe economies of scale and diseconomies of scale and what are the determinants of each, respectively?

          As a business increases in size, the LRAC can either lower (economy of scale) due to being able to produce and distribute at a lower cost, like new machinery for example.  This means that the business has the proper demand and is best suited to function as a large company, however, consumers might not see the benefit of such because these can turn into monopoly’s where the large industries do not lower costs because they know that the smaller businesses cannot compete either way (Amacher & Pate, 2013, Ch. 8.3)

          When a business increases in size and the LRAC goes up instead of down, it is considered a diseconomy of scale.  As this company is growing, it might not be able to communicate from the leadership down as effectively as when they were small scaled, leading to possible production and coordination issues.  This means that the larger the company gets, the higher the cost of each item will be to continue to sustain the company (Amacher & Pate, 2013, Ch. 8.3)

Using a real-world company (other than Sysco), explain the causes of economies of scale for your company and how could economies of scale help your company compete in its industry?

          David Trainer wrote an article about Sysco’s successful company, in this article he described Whole Foods and why it was acquired by Amazon.  Essentially, Whole foods had stores open nationwide, however, they could not lower prices due to higher cost of distribution (Sysco has the best distribution possible).  Using the lesson principles that we’ve learned; Whole Foods was a diseconomy of scale.  As this company grew larger, it could not keep up with the limiting factor of cheaper distribution, meaning it had to raise its LRAC instead of it decreasing.  This led to the company being bought out by Amazon (economy of scale) due to their impressive distribution capabilities.  This merger helps Whole Foods and Amazon become a better economy of scale (Trainer, 2018).  Sysco still outperforms them due to higher total revenue after tax, meaning they can reintegrate money for better technology and further outlets.  However, this merger will make Amazon a future competitor with Sysco and will hopefully make them respectively lower costs (minor reduction in profit) to compete which will benefit the consumer (Amacher & Pate, 2013, Ch. 8.3).

Resources

Amacher, R., & Pate, J. (2013). Microeconomics Principles and Policies. San Diego, California: Bridgepoint Education, Inc.

Trainer, D. (2018, January 29). Sysco feasts on economies of scale for strong competitive advantage. Forbes. Retrieved from https://www.forbes.com/sites/greatspeculations/2018/01/29/sysco-feasts-on-economies-of-scale-for-strong-competitive-advantage/#50fb48a8245e