ECONOMIES AND DISECONOMIES OF SCALE

The shape of the long-run average-total-cost curve conveys important information about the production processes that a firm has available for manufacturing a good. When long-run average total cost declines as output increases, there are said to be economies of scale. When long-run average total cost rises as output increases, there are said to be diseconomies of scale. When long run average total cost does not vary with the level of output, there are said to be constant returns to scale. In this example, Ford has economies of scale at low levels of output, constant returns to scale at intermediate levels of output, and  diseconomies of scale at high levels of output.

What might cause economies or diseconomies of scale? Economies of scale often arise because higher production levels allow specialization among workers, which permits each worker to become better at his or her assigned tasks. For instance, modern assembly-line production requires a large number of workers. If Ford were producing only a small quantity of cars, it could not take advantage of this approach and would have higher average total cost. Diseconomies of scale can arise because of coordination problems that are inherent in any large organization. The more cars Ford produces, the more stretched the management team becomes, and the less effective the managers become at keeping. costs down.

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