DHS Y5 H2 Economics_Content Clinic 3 Firms & Decisions

1 H2 Economics – Content Clinic 3 (Firms & Decisions) a. Key Definitions: i. Short Run is defined as a period over which at least one factor input is fixed. ii. Long Run is defined as a period over which all factors used in the production process are variable. iii. Economies of Scale refers to costs savings enjoyed from large-scale production. iv. Barriers to entry refers to anything that prevents or impedes the entry of new firms into an industry and thereby limits the degree of competition faced by existing firms. v. Allocative efficiency refers to the current combination of goods produced and sold that gives the maximum satisfaction for each consumer at the current level of income. vi. Productive efficiency refers to the situation when output is produced with the least costly combinations of inputs given the current level of technology. vii. Dynamic efficiency refers to the situation where firms are technologically progressive through investing in R&D to meet the changing needs and wants of consumers over time. viii. Equity is defined as a distribution of income that is considered to be fair or just.

2 Characteristics Internal Economies of Scale Diagram Explanation 1. Internal Economies of Scale (IEOS): • Increase in output → Less than proportionate increase in total cost → Average cost decreases • Sources of IEOS: Specialisation & division of labour, indivisibilities of machinery, bulk purchases, large scale advertising etc. • Example: By increasing its scale of production, a firm gets to enjoy marketing economies as its cost of advertising campaigns can now be spread over a larger output. This will lower average costs for the firm. With reference to the diagram above, an increase in the firm’s output from Q1 to Q2 allows it to enjoy lower average costs from C0 to C1, which is a movement along the firm’s LRAC. 2. Internal Diseconomies of Scale (IDOS): • Increase in output → More than proportionate increase in total cost → Average cost increases • Sources of IDOS: Managerial difficulties, low morale etc.

3 External Economies of Scale Diagram Explanation 3. External Economies of Scale: • Reduction in unit costs from expansion or growth of industry → LRAC shifts downwards • Sources: Better infrastructure within an area of concentrated operations, joint efforts in R&D by firms within the same industry • Example: As the chemical industry expands, more firms relocate their operations to Jurong Island. Due to the concentration of operations within the area, facilities such as better transport, roads and telecommunication systems may be set up to serve the needs of the industry, thereby lowering operating costs. With reference to the diagram above, the expansion of the industry thus leads to a downward shift in the firm’s LRAC from LRAC0 to LRAC1. The firm experiences a fall in its average cost from C0 to C1 for the same output level Q0. 4. External Diseconomies of Scale