Minimum Efficient Scale

1 January 2017

An individual factory can be categorized as a Short-run production, since it is only one factory, expanding the factory or building more factories will be considered as Long-run. Thus, the individual factory (one plant) of the firm is a fixed factor and the inputs are variable factors. The only way to expand firm production is to increase the outputs by increasing variable factors such as materials and labour. This process will lead to a similar theory of “economies of scale” consumption in the short-run period.

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MES will be relatively larger than MEPS in terms of production of outputs through this process. The example below will show why one plant cannot achieve MES, but instead only MEPS. Take the case of an Orange juice production firm with a single factory: The Variable factors include the number of workers and oranges (input), and the fixed factor is the factory itself. In order to increase output, the firm needs to increase the number of workers and oranges.

The “economies of scale” will occur when oranges from farms charges the firm a cheaper price (or discount) when the firm demands more oranges and when workers become more familiar with the environment and machines in the factory. However, since the factory has limited amount of workers and oranges it can hold, it will lead to the law of diminishing returns as it cannot produce more and more output. (When the SRAC curve rises it does not indicate the law of diminishing returns. ) According to Principles of Economics pg111, “The MES can be expressed in terms either of an individual factory or of the whole firm.

Where it refers to the minimum efficient scale of an individual factory, the MES is known as the minimum efficient plant size (MEPS). ” Hence, if MEPS applies to the individual Orange juice factory we can assume MEPS lies on the SRAC curve where it flattens off (end of economies of scale) as outlined below on Diagram 1: If the orange juice production firm wants to expand its production to a higher degree as the individual factory cannot hold any more workers and oranges, it will need to build more factories which leads to the Long-run production scale.

When each new factory is produced it is likely for the firm to experience economies of scale, thus new lower SRAC curves (SRAC1, SRAC2 and SRAC3) for every new factory as indicated on Diagram 2 ( There is a possibility for the firm to undergo diseconomies of scale at a certain point on the long-run. i. e. SRAC4. ). Each factory itself will achieve MEPS as well individually. As outlined before, MEPS will be achieved for individual plants in short-run production and provided that many SRAC curves make up a LRAC curve, the LRAC curve can be constructed by an envelope curve as it touches the tangent points of the SRAC curves.

When the LRAC curve is constructed, we are able to specify where the MES point lies on the curve as shown on Diagram 3: Through the discussion, we can conclude that MES will be achieved in firms with several factories in the long-run with a large production scale; however in an individual factory of a firm it can only achieve MEPS and not large enough to achieve MES due to its assumption category in the short-run. Furthermore, if the plant can cover the whole output of the industry it may still not reach MES, since it covers all production (monopoly) there is no competition and thus the firm charges customers a high price.

MEPS will be achieved through the short-run as outlined above, yet it cannot reach MES. 2) How does the table help us understand why the automobile industry in Australia has received tariff protection from imports? Tariff Protection is used to put taxes on imports in order to protect a country’s industry. In terms of automobile industry, this concerns ‘cars’ and ‘electrical motors’ on the table. Let’s take the case of UK’s and Australia’s Automobile industry.

As specified from the case study, Australia’s MES would be higher as its market is approximately one-third of UK’s which is relatively smaller. The given example calculation refers to cigarette production, where 24% in UK will be 73% in Australia. By using this example we can calculate the approximate MES for Australia in terms of the automobile industry. Thus, Cars will be 600% (200% x 3) and electrical motors will be 180% (60% x 3). It is important to know the MES of Australia’s automobile industry to compare the MES of UK that is reflected on the table.

In reference to page 111-112 of Principles of economics, when “MES exceeds 50% there will not be room for more than one firm large enough to gain full economics of scale….. said to be natural monopoly”. The electrical motors and Car industries will therefore be natural monopolies in both Australia and UK, and no competition will occur. As Australia’s MES (600%) is larger than UK’s (200%), imports will severely affect Australia’s industry. This is because UK itself has the initiate advantage as it is more developed and has a larger market than Australia.

Australia will be more inferior (to UK’s) and if they freely allow UK’s automobile industry to merge in, their own industry will not survive from the competition. Similarly, EU have an even smaller MES and it is likely for them to overwhelm in terms of number of firms (20% cars & 6% electrical motors are under 50%, thus there are competitions in EU) if imported to Australia’s economy. Refer to Diagram 4. For Australia to protect its own automobile industry it is essential to receive tariff protection.

This will charge other countries taxes to create a barrier to enter Australia’s economy. Thus will allow its automobile industry to expand and develop in time. In conclusion, the table allows us to understand why Australia has received tariff protection due to the major difference of MES of UK and EU with Australia. Because UK and Australia faces monopoly (over 50% MES), they will compete each other if UK can freely join into Australia’s automobile industry. UK will likely overpower Australia due to its large market (more developing) and Australia will not survive. ———————- SRAC Output Costs MEPS Diagram 1: Individual plant SRAC cure of an Orange Juice production firm SRAC2 SRAC1 Economies of scale of the whole firm (LR) MEPS SRAC3 SRAC4 Output Cost Diagram 2: SRAC curves of each new factory. Each curve achieves MEPS Cost Output SRAC4 SRAC3 SRAC2 SRAC1 MES MEPS LRAC Diagram 3: LRAC curve formed from SRAC curves with MES point Diagram 4: Table from Case Study Principles of Economics p112. Essential information for answer

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