this is video number eight in the theory of the firm series uh this video will focus on the costs of production in the long run remember this is high level only component of the ib economics syllabus in this video my main focus will be explaining and describing the factors that lead to economies of scale or the factors that give rise to economies of scale and the factors that give rise to dis economies of scale so in the previous video in this series we have seen the long run average cost curve and we said that the long run average cost curve is an envelope curve encompassing an infinite number of short run curves because the long run is really just a series of short runs firms are never really in the long run for a long period of time they basically move from one short run to the other so as you can see here there's the long run average cost curve and there's a series of different short run average cost curves it's actually an infinite number that can be contained remember on the y-axis we have the costs of production in dollars on the x axis we have the level of output now let's look at the shape of the longer and average cost curve remember it's a relationship between the long run costs of production and the level of output and we are measuring the long run average cost so the cost per unit in the long run you'll see that there is a range of output where the long run average cost is falling so this range of output the long run average cost is falling then it reaches a minimum and then there's a range of output where the long run average cost is rising now when the long run average cost of production is falling we say that the firm is experiencing economies of scale economies of scale is the fall in the long run average costs or the long run costs per unit due to increasing the scale of production or due to the firm producing more output and increasing all of its factors of production economies of scale is what gives rise or what leads to the firm experiencing increasing returns to scale as i mentioned earlier there is a range of output where the long run average cost is actually increasing in this situation we say that the firm is experiencing dis economies of scale so this economies of scale is the opposite of economies of scale it is the rise in the long run average cost or the long run costs per unit due to increasing the scale of output or the firm increasing all levels of its factors of production this economies of scale is the opposite of economies of scale and this economies of scale is what gives rise to the phenomenon that we call decreasing returns to scale it's when the firm increases all levels of its inputs say by a hundred percent but then the return that they get from increasing this output the for from increasing these inputs the output doesn't increase by the same amount it increases by a lower amount so say for example you double all of your inputs but your output only increases by 20 in this situation you've experienced decreasing returns to scale as well as dis economies of scale now i mentioned earlier that economies of scale is what gives rise to increasing returns to scale but what is the difference between them both well economies of scale looks at the cost of production the cost of production specifically the long run average cost the long run average cost is decreasing as output is increasing but increasing returns to scale looks at the output or the production side of things so increasing returns to scale occurs when increasing returns to scale occurs when the increase in all levels of inputs so i here is inputs is less than the increase in output so when you increase all of your inputs by a certain amount and then the increase in output is greater than the increase in inputs yes economies of scale gives rise or leads to the firm experiencing increasing returns to scale but economies of scale looks at the costs okay side of things the long run average cost while increasing returns to scale looks at the output side of things the same is true with this economies of scale so this economies of scale looks at the cost side of things while decreasing returns to scale looks at the output side of things with this economies of scale the long run average cost is rising okay due to increasing the level of output so this economies of scale looks at the costs okay it looks at the cost side of things it's a phenomenon to do with the costs of production while decreasing returns to scale looks at the output it's a phenomenon that is more concerned with the level of output compared to the change in the level of inputs decreasing returns to scale occurs when you increase your inputs but the increase in output is less than the increase in inputs and this is called decreasing returns to scale now it also helps to understand the meaning of the actual terminology so economies is really another fancy word for savings okay so savings okay and scale here is really another fancy word for growing bigger or growing larger so we'll say growth okay so really economies of scale is savings that the firm experiences as a result of a growth in its size remember that this economies on the other hand is the opposite these are say unsavings due to continuing to grow in size so economies of scale basically looks at the savings that the firm experiences as a result of the growth in its level of inputs and outputs in the long run now let's look at what causes economies and economies of scale so the factors that give rise to economies of scale or the factors that cause economies of scale these sources and types of economies of scale this is what we are discussing right now first of all specialization as a firm grows bigger it it becomes more specialized and the managers within it and the workers within within the firm become more specialized this also leads to more division of labor because the firm has grown larger it can divide the labor more and this causes it to be more efficient when a firm grows bigger it can order its supplies in bulk so bulk buying means the firm can negotiate discounts with suppliers remember economies of scale refers to savings as a result of growing bigger remember that there's also financial economies a bigger firm can afford to take out loans from banks at a cheaper interest rate it has more options in terms of raising finance transport economies as a result of growing bigger the firm can buy better trucks bigger trucks which lower its average cost its cost per unit it can transport in bulk which again reduces its transportation costs technical economies the firm as is growing larger it can employ more technical machinery that is more efficient and that causes uh cost savings in the long run and last is promotional economies so these are savings that come from the marketing budget just because you're growing larger doesn't necessarily mean your promotion costs and your marketing costs have to grow as well so these are all sources or types of economies of scale these are the factors that cause a firm to save some money and to lower its average cost as it grows larger in the long run now what about the factors that give rise to dis economies of scale what are the sources of this economies of scale the first one is control and communication problems remember this economies of scale is the opposite of economies of scale so the firm is now experiencing uh dis savings it's it's actually experiencing a rise in its average cost because of growing bigger so basically control and communication problems occur when the firm has grown too big that it's become very difficult to control and very difficult to communicate within the firm also alienation and loss of identity when a firm grows really big its employees its workers can sometimes feel alienated and and feel like they're part of something really big that they don't feel like they're making a difference this leads to a loss of identity and it could affect their productivity and their efficiency levels so it's not always good for a firm to keep growing in size because at some point you're going to grow too big you can experience this economies of scale the firm becomes difficult to control it becomes difficult to communicate the workers may feel really alienated and lose their identity and therefore might not feel very loyal might not be very efficient or productive and these are the factors that give rise to diseconomies of scale so far we've only been looking at internal economies of scale and internal dis economies of scale these are the economies or diseconomies of scale that occur as a result of the growth in the size of the firm itself so we're looking internally inside the firm itself however there is also external economies of scale and external diseconomies of scale and these occur due to the growth in the size of the industry the whole industry is growing the industry in which the firm operates an example of external economies of scale is when a number of similar firms that produce the same thing for example all concentrate in one area so say for example if you go to a if you go to silicon valley for example in silicon valley you have a lot of high-tech firms concentrating over there there must be benefits due to this concentration maybe a lot of ancillary firms that provide components would also set up there maybe there would be a pool of skilled workers so this could lead to external economies of scale the whole industry is growing and thus the firm is experiencing cost savings or falling costs per unit external diseconomies of scale happens when too many firms concentrate in the same area and this could lead to competition for workers competition for resources and supplies and raw materials which could eventually lead to rising costs of production so remember internal economies and diseconomies of scale occurred due to growth in the size of the firm itself external economies and diseconomies of scale occur to the growth in the size of the industry itself or the concentration of many similar firms in the same area