Cost Theory-Long Run
Economies of Scale- Exists when a firm increases output and increases both variable and fixed factors, whereas output increases at a proportionally higher rate than the increase in costs per unit. Thus average costs fall as firms achieves increased output per unit of input. This happens in both the Short Run and the Long Run. This is known as benefits of scale. Economies of scale are often good for consumers because they get their goods for a cheap price, because the economy of scale has such low production costs compared to their profit, they are able to sell their goods for very cheap.
Example: Walmart is an example of an economy of scale because it can increase both its variable and fixed factors. Because much of their production takes place in China, the costs are low, so they are able to sell their goods at a low price. This can be seen in Figure 1 as a decrease in SRAC from SRAC0 to SRAC1 is met with an increase in the quantity being produced, and there is a decrease in the LRAC as the quantity produced increases. Figure 1
Diseconomies of Scale-Exist when there is a rise in long-run average costs, due, for example to communication problems and lack of control in an increasingly complex organization. i.e. the company gets too big to efficiently manage. This can be shown in Figure 2 as, initially, there is an economy of scale with a decrease in both SRAC and LRAC but once the LRAC curve begins to shift up, the SRAC begins to rise with the rise in the LRAC, as shown by the shift up of SRAC from SRAC5 to SRAC6. Few studies though have shown conclusive evidence that diseconomies of scale actually exist. Usually, when a firm gets too big to efficiently manage, the firm scales back its production or is able to cut costs in other ways to avoid becoming a diseconomy of scale.
Figure 2
Taxes
Flat rate- tax system with a constant marginal tax rate. This kind of tax system has a regressive effect on individuals in the form of indirect taxes. Products such as alcohol, tobacco and petrol, which are heavily taxed and are a major contributor to total government tax revenue is a flat rate tax as everyone who buys these products pays the same tax. But the poor who buy these products give up a higher proportion of their income than the rich do. This can be seen in Figure 3 as a Regressive tax, as the Total Tax Payment for the Regressive tax decreases as Gross income increases.
Figure 3
Ad valorem tax- tax based on the assessed value of real estate or personal property. An example of an ad valorem tax would be property tax. Property tax increases if you live in a nice neighborhood, meaning someone who lives in a nice neighborhood will pay more property tax than someone who lives in a neighborhood with a higher crime rate.
Economies of Scale- Exists when a firm increases output and increases both variable and fixed factors, whereas output increases at a proportionally higher rate than the increase in costs per unit. Thus average costs fall as firms achieves increased output per unit of input. This happens in both the Short Run and the Long Run. This is known as benefits of scale. Economies of scale are often good for consumers because they get their goods for a cheap price, because the economy of scale has such low production costs compared to their profit, they are able to sell their goods for very cheap.
Example: Walmart is an example of an economy of scale because it can increase both its variable and fixed factors. Because much of their production takes place in China, the costs are low, so they are able to sell their goods at a low price. This can be seen in Figure 1 as a decrease in SRAC from SRAC0 to SRAC1 is met with an increase in the quantity being produced, and there is a decrease in the LRAC as the quantity produced increases.
Figure 1
Diseconomies of Scale-Exist when there is a rise in long-run average costs, due, for example to communication problems and lack of control in an increasingly complex organization. i.e. the company gets too big to efficiently manage. This can be shown in Figure 2 as, initially, there is an economy of scale with a decrease in both SRAC and LRAC but once the LRAC curve begins to shift up, the SRAC begins to rise with the rise in the LRAC, as shown by the shift up of SRAC from SRAC5 to SRAC6. Few studies though have shown conclusive evidence that diseconomies of scale actually exist. Usually, when a firm gets too big to efficiently manage, the firm scales back its production or is able to cut costs in other ways to avoid becoming a diseconomy of scale.
Figure 2
Taxes
Flat rate- tax system with a constant marginal tax rate. This kind of tax system has a regressive effect on individuals in the form of indirect taxes. Products such as alcohol, tobacco and petrol, which are heavily taxed and are a major contributor to total government tax revenue is a flat rate tax as everyone who buys these products pays the same tax. But the poor who buy these products give up a higher proportion of their income than the rich do. This can be seen in Figure 3 as a Regressive tax, as the Total Tax Payment for the Regressive tax decreases as Gross income increases.
Figure 3
Ad valorem tax- tax based on the assessed value of real estate or personal property. An example of an ad valorem tax would be property tax. Property tax increases if you live in a nice neighborhood, meaning someone who lives in a nice neighborhood will pay more property tax than someone who lives in a neighborhood with a higher crime rate.