Summary of Economics of Strategy Book Essay

The total cost of production of Sony’s new product is the addition of both fixed and variable costs. Fixed costs are assets within a business that are not used up or sold during the typical production course e.g. buildings and machinery. Variable costs are costs that fluctuate in time with the production output or sales revenue of a company such as Sony e.g. raw material and labour costs. Figure 1.1 shows how the total cost is composed of both fixed and variable costs.

Larger firms tend to have lower cost compared to smaller firms, due to the fact that they are able to gain from economies of scale, but it is possible for larger firms to experience diseconomies of scale. As firms increase their production scale they tend to lower their production cost and move to the long run, this can be represented using the diagram

The Marginal Cost graph intersects the Average Total Cost graph and the Average Variable Cost graphs at their minimum points. As long as the cost of producing one additional unit remains less than average total cost, the average total cost continues to fall. When marginal cost finally exceeds average total cost, average total cost begins to rise in response. The same effect applies to the relationship between marginal cost and average variable cost.

In microeconomics, economies of scale can be defined as a scale which is there when lager output is obtained with the lower per unit cost this is because the fixed cost is spread over the more units produced or generated.

(Long-Run Costs) Suppose the firm has only three possible scales of production as shown below:

The proportionate saving in costs gained by an increased level of production is with a higher output , it comes with a cheaper overall cost

-Economies of scale are very important for a low-value product, which is more difficult for new entrants to compete with existing manufacturers

Mass production is inflexible because it is difficult to alter a design or production process after a production line is implemented. Also, all products produced on one production line will be identical or very similar, and introducing variety to satisfy individual tastes is not easy. However, some variety can be achieved by applying different finishes and decorations at the end of the production line if necessary.

On the other hand, economies of scale occurs when firms expand their scale of production as they gain benefits in some aspects. Strategically, large firms can afford to advertise or even provide additional services such as free delivery. With a large output, the average cost of advertising and the provision of services per output reduce. Besides, when purchasing raw materials in bulk, large firms are often given discounts. Financially, large firms are well-established and reliable so finance is more accessible and interest rate is also relatively lower.

CH 3. 2. Appalachian Coal Mining believes that it can increase labor productivity and, therefore, net revenue by reducing air pollution in its mines. It estimates that the marginal cost function for reducing pollution by installing additional capital equipment is MC = 40P where P represents a reduction of one unit of pollution in the mines. It also feels that for every unit of pollution reduction the marginal increase in revenue (MR) is MR = 1,000 - 10P

Ans: Marginal cost (MC) is the extra total cost resulting from 1 extra unit of output. Average total cost resultiong is the sum of ever decling average fixed cost (AFC) and average variable cost (AVC). Average total cost stands for (AC). In the short run the costs are generally represented by a U- shaped curve that is always intersected at its minimum point by the rising MC curve.

Enlarging the operation scale is a indispensable way for manufactures when developing a company. Once fixed cost was determined, the more units produced, the more efficient that production becomes. Marginal costing is a very effective way of measuring whether economies of scale are saving the business capital. It perfectly avoids manipulation of short-term profit, overcoming the shortcoming of the full cost method, making significant contribution to short term production decisions. The following example will present this merit clearly:

No economies of scale – With zero economies of scale, firms cannot depend on the fact that higher production will lead to falling average cost. Hence, there is increasing marginal cost with the production of higher output and there is no benefit from increasing sale.

1. Total cost is the figure that describes the total cost of production for an organisation. It is made up of both fixed costs, which are costs that are fixed in relation to output, and variable costs, which are costs that vary depending on the level of output. Before production commences, the total costs of the organisation will be the same as the fixed costs, as no raw materials or labour have been utilised. Although when production increases, variable costs will also rise, meaning the total costs will increase. This can be shown by the diagram below:

Increasing returns are the natural outcome of decreasing output costs and have external and internal factors which influence economies of scale (Ossa, n.d.). Economies of scale are influenced externally by industry size, rather than firm size and include