Minimum Efficient Scale
Encyclopedia
Minimum efficient scale or efficient scale of production is a term used in industrial organization
to denote the smallest output that a plant (or firm) can produce such that its long run average costs are minimized.
(AC) and equating it to 0. This would represent the minimum average cost that the firm is incurring per quantity produced.
(AC) with the Marginal Cost
(MC). The rationale behind this is that when a firm produces a smaller number of units, its Average Cost
per unit is high because a bulk of the costs come from Fixed Costs. As a firm produces more units, the Average Cost
incurred per unit will tend to "average out" and move towards the cost it takes to produce each additional unit (Marginal Cost
). The efficient scale of production is then reached when the Average Cost
is the same as its Marginal Cost
.
of a market. For instance, if the minimum efficient scale is small relative to the overall size of the market (demand for the good), there will be a large number of firms. The firms in this market will be likely to behave in a perfectly competitive manner due to the large number of competitors.
Industrial organization
Industrial organization is the field of economics that builds on the theory of the firm in examining the structure of, and boundaries between, firms and markets....
to denote the smallest output that a plant (or firm) can produce such that its long run average costs are minimized.
Computing
Mathematically, the efficient scale can be computed by either taking the first order derivative of the Average CostAverage cost
In economics, average cost or unit cost is equal to total cost divided by the number of goods produced . It is also equal to the sum of average variable costs plus average fixed costs...
(AC) and equating it to 0. This would represent the minimum average cost that the firm is incurring per quantity produced.
Relationship to average cost and marginal cost
Another way the efficient scale can be computed is by equating Average CostAverage cost
In economics, average cost or unit cost is equal to total cost divided by the number of goods produced . It is also equal to the sum of average variable costs plus average fixed costs...
(AC) with the Marginal Cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
(MC). The rationale behind this is that when a firm produces a smaller number of units, its Average Cost
Average cost
In economics, average cost or unit cost is equal to total cost divided by the number of goods produced . It is also equal to the sum of average variable costs plus average fixed costs...
per unit is high because a bulk of the costs come from Fixed Costs. As a firm produces more units, the Average Cost
Average cost
In economics, average cost or unit cost is equal to total cost divided by the number of goods produced . It is also equal to the sum of average variable costs plus average fixed costs...
incurred per unit will tend to "average out" and move towards the cost it takes to produce each additional unit (Marginal Cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
). The efficient scale of production is then reached when the Average Cost
Average cost
In economics, average cost or unit cost is equal to total cost divided by the number of goods produced . It is also equal to the sum of average variable costs plus average fixed costs...
is the same as its Marginal Cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
.
Relationship to market structure
This concept is useful in determining the likely market structureMarket structure
In economics, market structure .* Monopolistic competition, also called competitive market, where there are a large number of firms, each having a small proportion of the market share and slightly differentiated products.* Oligopoly, in which a market is dominated by a small number of firms that...
of a market. For instance, if the minimum efficient scale is small relative to the overall size of the market (demand for the good), there will be a large number of firms. The firms in this market will be likely to behave in a perfectly competitive manner due to the large number of competitors.
See also
- Economy of scale
- Diseconomies of scaleDiseconomies of scaleDiseconomies of scale are the forces that cause larger firms and governments to produce goods and services at increased per-unit costs. The concept is less well known than economies of scale.-Communication costs:...
- Ideal firm sizeIdeal firm sizeThe ideal firm size is the theoretically most competitive size for any company, in a given industry, at a given time; which should ideally correspond with the highest possible per-unit profit.- Discussion :...
- Long run average cost