Economies of Scale and Imperfect Competition How can large companies afford to l

Question

Economies of Scale and Imperfect Competition How can large companies afford to lower the price of goods in a competitive market? A company’s ability to raise its price without losing its entire market is an example of market power. One of the most important of these is economies of scale. Post by Day 3 a 250- to 300-word statement that addresses the following: •How do companies develop economies of scale? •Why do economies of scale often result in monopolistic or oligopolistic markets? •Explain the role of government in regulating these monopolies or oligopolies?

Explanation / Answer

Large companies afford to lower the price of goods in a competitive market because they develop a brand value over time. Also large companies might enjoy economies of scale over time, which may reduce its marginal cost of production of a good, hence, it is possible for them to reduce the price of good even in a competitive set up. Hence, a company’s ability to raise its price without losing its entire market can be because of market power or because of economies of scale.

Companies develop economies of scale

Economies of scale is an economic concept that describes growth in output such that the costs incurred during production are spread over an increased volume of production. When production increases, the per-unit fixed cost of production decreases.

1. Lower input costs: When a company buys inputs in bulk - for example, potatoes used to make French fries at a fast food chain - it can take advantage of volume discounts. Hnece, large companies are more liable to enjoy this discount.

2. Costly inputs: Some inputs, such as research and development, advertising, managerial expertise and skilled labor are expensive, but because of the possibility of increased efficiency with such inputs, they can lead to a decrease in the average cost of production and selling. If a company is able to spread the cost of such inputs over an increase in its production units, ES can be realized.

3. Specialized inputs: As the scale of production of a company increases, a company can employ the use of specialized labor and machinery resulting in greater efficiency. This is because workers would be better qualified for a specific job and would no longer be spending extra time learning to do work not within their specialization. Specialization can lead to economies of scale because it allows for increased output. Economic theory indicates that specialization is conducive to growth. Specialization, in economic terms, means focusing on one task rather than multiple tasks toward productive output.

4. Techniques and Organizational inputs: With a larger scale of production, a company may also apply better organizational skills to its resources,while improving its techniques for production and distribution.

5. Learning inputs: Similar to improved organization and technique, with time, the learning processes related to production, selling and distribution can result in improved efficiency.

Hnece, a few large firms which are able to achieve economies of scale, can sell their goods at a lower price. This draws the demand towards them from small producers. Hence, they achieve market power, and resultantly become monopolistic or oligopolistic markets. Monopoly which a single large firm, while oligopolistic when few large firms exist which are experiencing economies of scale.

To protect consumers from such market structures, by first making small businessses go out of business and then increasing prices to reap higher benefits, governments often try to control the market power of monopolies and oligopolies. One way to do this is is through regulation.   A second way to control the market power of monopolies is through nationalization, in which the government owns and operates the monopoly.

The Government Regulates Monopolies to:

The Government can Regulate Monopolies by

1. Price Capping

2. Regulation of quality of service

3. Merger Policy - The government can have a policy to investigate mergers which could create monopoly power.

4. Breaking up a monopoly - In certain cases, government may decide a monopoly needs to be broken up because the firm has become too powerful.

5. Yardstick or ‘Rate of Return’ Regulation - Rate of return regulation looks at the size of the firm and evaluates what would make a reasonable level of profit from the capital base. If the firm is making too much profit compared to their relative size, the regulator may enforce price cuts or take one off tax.

6. Investigation of Abuse of Monopoly Power through various laws.

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