Holt 7525-9 S15_IT

If the scale of operation is increased too much, diseconomies of scale will occur. Diseconomies of
scale typically occur because large size creates problems of communication, coordination, and
control.
Example 9: A restaurant with seating for 200 patrons may be taking good advantage of
economies of scale, with a specialized labor force and a well-equipped kitchen. But a restaurant
with seating for 2,000 patrons would likely be unmanageably large, due to communication,
coordination, and control problems.
The extent to which economies of scale exist will affect the number of competitors in an industry.
To compete effectively, each firm will need to achieve the minimum efficient scale.
Minimum efficient scale – the smallest scale of operation that will allow a firm to achieve
minimum long run average total cost.
If the minimum efficient scale in an industry is relatively small, there will likely be many small
producers in the industry, e.g. restaurants in a large city. If the minimum efficient scale is
relatively large, there will be a few large producers, e.g. commercial airplane manufacturing.
Appendix: Total Revenue, Total Cost, and Break-Even
This chapter has focused on production and costs of production. Emphasis has been placed on
the marginal cost of production and on the average costs of production. These costs will be
emphasized in Chapter 21 as we look at the profit-maximization rule.
Our understanding of fixed costs, variable costs, and total cost can be enhanced by examining
these cost curves on a graph. We will also include a total revenue curve and a marginal revenue
curve. We will identify the break-even quantity (where total revenue and total cost are equal) and
the profit-maximizing quantity (where marginal revenue and marginal cost are equal).
Total revenue is equal to the selling price of the output multiplied by the quantity sold. Marginal
revenue is the change in total revenue from selling an additional unit of output.
Example 10: Refer back to Example 6. Assume that Robin Birdwell can sell the luxury
birdhouses for $85 each. The table below shows the costs of production, total revenue, marginal
revenue (explained in Chapter 21) and profit. The graph on the next page illustrates the fixed cost
curve, the variable cost curve, the total cost curve, the marginal cost curve, the total revenue
curve, and the marginal revenue curve.
Birdhouse Total Fixed Variable Marginal Marginal Total
Quantity Cost Cost Cost Cost Revenue Revenue Profit
0 $120 $120 $0 X X $0 $-120
1 160 120 40 $40 $85 85 -75
2 190 120 70 30 85 170 -20
3 230 120 110 40 85 255 25
4 285 120 165 55 85 340 55
5 360 120 240 75 85 425 65
6 460 120 340 100 85 510 50
7 590 120 470 130 85 595 5
8 755 120 635 165 85 680 -75
On the graph on the next page, the break-even quantity occurs where total revenue and total cost
are equal (where the TR curve and the TC curve intersect). The break-even quantity for Robin
Birdwell occurs between two and three birdhouses. We will see in Chapter 21 that the profitmaximizing
quantity occurs where marginal revenue and marginal cost are equal (where the MR
curve and the MC curve intersect). This intersection occurs between five and six birdhouses.
Thus, the profit-maximizing quantity for Robin Birdwell is five birdhouses.
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20 - 9 Production and Costs