NOTE: Free essay sample provided on this page should be used for references or sample purposes only. The sample essay is available to anyone, so any direct quoting without mentioning the source will be considered plagiarism by schools, colleges and universities that use plagiarism detection software. To get a completely brand-new, plagiarism-free essay, please use our essay writing service.
One click instant price quote
Economies of Scale According to the traditional neoclassical analysis based on the structure-conduct-performance paradigm, the efficiency of a market is determined by its level of concentration and the extent of collusion between the existing firms. Any deviations from the ideal of perfect competition are thought to involve dead-weight losses and hence warrant some sort of government intervention. This has been recently challenged by the contestable markets theory, put forward by Baumol (1982) according to which a perfectly contestable market is characterized by optimal behavior yet applies to all market structures. economic of scal ar th mony firm could sav, when it xp ands its.
For xml, if firm's average cost pr 1 unit is 10 at th output of 100 unit and when it xp ands its output to 200 unit, th average cost pr 1 unit drops to 8, thn th firm nos economic of scal. So thy occur, when a prcntag increase quality in all inputs lads to a great prcntag chang in output. Inputs ar land, labour and capital and output ar th goods and services th firm produc's. economic of scal occur only in long run and can b david into two groups: internal and xtr nal economic of scal.
According to th will accepted definition, economic of scal ar known as declining long-run average cost that occurs as a firm increase all inputs and xp ands its scal of production. This is graphically illustrated by a negatively-shop long-run average cost car and typically occurs for relatively small lvls of production. economic of scal ar thn ovrwhlmd by disconomis of scal for relatively larg production lvls. Together, economic of scal and disconomis of scal caus th long-run average cost car to b U-said. Disconomis of scal, constantly, can b did as increasing long-run average cost that occurs as a firm increase all inputs and xp ands its scal of production. This is graphically illustrated by a positive-shop long-run average cost car and typically occurs for relatively larg lvls of production.
Disconomis of scal overwhelm by economic of scal for relatively larg production lvls. In the neoclassical theory, the smaller the number of agents, the more market power they have and the more price diverges from MC with the extreme case being that of a monopoly. It may be noted here that a "pure" monopoly is one which has zero cross elasticity of demand which implies that complete monopoly is virtually non-existent. Also monopoly and oligopoly do not mean that the incumbents always have supernormal profits but simply that they can have such profits even in the long run. Moreover, the efficiency losses of monopoly are greater the more inelastic the demand is. It has to be taken into account, however, that the scale economies obtained by big firms may counterbalance the allocation inefficiency of monopolies.
The policy implications of the neoclassical theory are to encourage competition except when the economies of scale are large enough, to regulate, subsidize or even nationalize concentrated industries to avoid the dead-weight loss involved and tax their profits to offset the distributional effects of monopoly pricing. There are a number of problems, however, with this traditional story such as the endogeneity of the market structure and the theory of second best which suggests that perfect competition need not be the optimal structure for any particular industry if the whole economy is not fully perfectly competitive. One can easily see that a perfectly contestable market is pareto efficient since it has to be x-efficient, produce at MES, set P = MC and earn only normal profits: prices cannot be above MC because hit and run entry would occur while in this model it makes no sense to set prices below MC, i. e. conduct a price war since after eliminating an incumbent or enforcing a cartel, new entry would occur again. These also imply that no cross subsidization can occur.
This is not true only for natural monopolies which cannot charge P = MC because they would make losses, so price will be equated to AC. Even in this case, though, the allocation inefficiency is reduced and the natural monopoly does not have super normal profits. Strictly speaking, pareto efficiency will also not be achieved in cases where the number of firms producing at MES is a fraction but this complication can be avoided if one accepts that we usually have saucer shaped cost curves. Moreover, the standard assumptions for the lack of externalities are obviously still valid. The implications for this are that all market structures can behave as if they were perfectly competitive so that the power and reach of the invisible hand are considerably increased. It should be noted, however, that although it is frequently argued that contestable markets are a generalization of perfectly competitive ones, this is not strictly speaking true since the latter make the additional assumption that the incumbents are slower to adjust their prices than entrants; the significance of this assumption will be discussed later on.
This theory also frees 1 oligopolies from dependence on conjectural variations of incumbents and argues that market structure defined as the number of firms in an industry is unimportant. The policy prescriptions of this approach are that regulations can often have perverse effects as they may obstruct the freedom of exit and that policies to reduce entry barriers should be preferred to such measures as splitting up companies to artificially enforce competition. Economies of scale are also important since in the absence of complete and fully efficient capital goods markets, much of the specialized equipment needed will have to be subsequently sold at a considerable loss. Given that we are interested in concentrated industries, the possible buyers for these equipment will be few and possibly reluctant as they will be the incumbents who want to discourage entry.
Thus, the greater the economies of scale and the more specialized the necessary equipment, the higher the sunk costs and the entry barriers. Product differentiation can also act as a barrier to entry since it involves many elements of sunk cost. In the case of quality differentiation, coupled with uncertainty for that quality, consumers are prepared to pay a premium for the incumbent firm. On the other hand, a large product range may reduce entry barriers since the entrant is easier to find a niche.
Indeed Dixit found that if no firm has a clear quality advantage, lower cross-elasticity of D i. e. greater product differentiation, lowers entry barriers. We can understand that in the extreme case of zero cross elasticity of demand, in which case the entrant simply ignores the incumbents. On the other hand, of course, the incumbent can also then ignore the entrant and raise his prices so there must be a trade off. [? ] A large product range also has implications for the economies of scale: on the one hand, it may mean that the production of each particular product will be small so the economies of scale won 1 t be large but on the other a firm may need to enter with many products simultaneously, partly to obtain technical economies and partly to obtain consumer good will which gets us to the issue of advertising. Advertising is often thought to be a genuine sunk cost given how intangible it is, although it could be argued that a very visible company in one sector can use this reputation in other sectors as well.
Furthermore, it is likely that there exist asymmetries in advertising, i. e. advertising having to be above a certain level for it to be effective in which case economies of scale are once more important. Quite clearly, the conditions for perfect contest ability are not more plausible than those for perfect competition but the question is how robust the theory is to small deviations in its conditions. As far as the assumptions of no entry lags and of no sunk costs are concerned, the theory is relatively robust, i. e.
its power gradually diminishes as the lag gets longer and sunk costs increase. There are several ways to test for the significance of entry barriers and hence for the applicability of the contestable markets hypothesis: A first possibility is the structural analysis pursued among others by Bain (1956). He found that profit rates were 50 % higher in industries judged to have very high barriers to entry, particularly due to product differentiation. Economies of scale, are found by engineering studies done by Bain and others to be very significant in the UK where almost all industries had a MES larger than 10 % of the market, while in the USA this percentage is much lower. On the other hand, international trade means that the size of the internal market may not be the correct measure to look at. Furthermore, the AC curves appear quite flat so that the penalty for being small is not as great.
Other ex post studies of economies of scale, based on which plant size is expanding relative to the others or on the firms who have more than one plant, find much smaller MES estimates. It is likely that the barriers on mobility and the degree of product differentiation within the broad industries considered in those studies may explain the large number of small firms operating in them. Sunk costs independent of economies of scale may also be important. One would expect that in industries where equipment is versatile between product lines or even other industries, sunk costs and hence prices and profits would be lower.
Indeed the classic example of the contestable market is that of the airlines which can switch their fleet between routes with little sunk costs. Even within the airline industry Bailey and Panzar (1981) found that the long haul routes in the US since deregulation in the late 701 s, supply, were prices competitively even when specific routes were a natural monopoly because trunk airlines have large many haul aircraft which can be switched to alternative routes while for the more specialized short-haul traffic, prices were well above their competitive level. Other studies have looked to the relation between profits, entry barriers and entry rates. Orr 1 s pioneering study for Canada found capital requirements, advertising intensity and high concentration to be significant barriers to entry.
Gorecki extended this study to examine for foreign firms and found that foreign subsidiaries were not affected by entry barriers and were more affected by industry growth, indicating the importance of diversification entry. It is also generally found that while there is a lot of entry and exit taking place, it is predominantly in the form of small firms, probably in order to minimize risks and permit learning by doing. Furthermore, entry does not seem to be very responsive to changes in expected profits, though other factors such as risk may be at work here. Furthermore new small entrants find it difficult to grow large although deliberate hit run entry is very rare.
Given that the impact of small firms is generally limited, evidence that competition between incumbents more important in keeping prices down. To understand the causes and consequences of scale effects, one needs to model a two-stage production process. In the second stage, which is the only stage modeled in standard production theory, some final output is altered by replicating identical units at a faster or a slower rate. In the first stage, a capital good is produced to provide a capital service to be used in the second stage. If more capital service input is required in the second stage of production, the capital good produced in the first stage may either be replicated (where this is physically possible) or reconfigured. Reconfiguration alters the physical, input, and output descriptors of the required capital good.
Our worlds three dimensional structure and its physical and chemical laws dictate many scale effects, some of which cause increasing returns to reconfiguration while others cause decreasing returns. Thus, one cannot understand either the sources of scale effects or their consequences without a great deal more empirical knowledge than is assumed in any standard micro theory text. Bibliography: Becattini, G. , (1987) Internal Economies, in Eatwell, Milgate, and Newman 1987, vol. 2: 889 - 91. Cardwell, Donald (1995), The Norton History of Technology, (New York: Norton). Chandler, Alfred D. (1990), Scale and Scope: The Dynamics of Industrial Capitalism, (Cambridge, Mass: Harvard University Press).
Dudley Leonard M. , (1991), The Word and the Sword, (Oxford: Blackwell). Eaton, B. Curtis, Richard G. Lipsey (1997), Increasing Returns, Indivisibility and All That in, On the Foundations of Monopolistic Competition and Economic Geography (Cheltenham: Edward Elgar). Eatwell, J. , M. Milgate, and P.
Newman (eds. ) (1987) The New Palgrave, a Dictionary of Economics, (London: Macmillan). Eatwell, J. , (1987) Returns to Scale in Eatwell, Milgate, and Newman, 1987, vol. 4: 165 - 6. Hiscock, Eric C. (1965), Cruising Under Sail, (Oxford: Oxford University Press). Koopmans, T. C. (1957) Three Essays on the State of Economic Science, (New York: McGraw Hill). Landes, David S. , (1969) The Unbound Prometheus, (Cambridge: Cambridge University Press).
Lipsey, Richard G. , C. Bear and K. Carl (1998), General Purpose Technologies: What Requires Explanation, Chapter 2 in General Purpose Technologies and Economic Growth, Elhanan Helpman (ed. ), (Cambridge: MIT Press). Oi, W. , (1987) Fixed Factors in Eatwell, Milgate, and Newman, 1987: vol. 2: 384 - 5.
Rosenberg, N. and L. K. Birdzell (1986), How the West Grew Rich, (New York: Basic Books). Silvestre, J. , Economies and Dis economies of Scale in Eatwell, Milgate, and Newman 1987: vol. 2: 80 - 83. Vassilakis, Increasing Returns to Scale in Eatwell, Milgate, and Newman, 1987: vol. 2: 761 - 65.
Free research essays on topics related to: perfect competition, average cost, perfectly competitive, increasing returns, entry barriers
Research essay sample on Entry Barriers Perfectly Competitive
