Principles of Economics Continuous Assessment - Essay Example

Minimum efficient scale Minimum efficient scale, The Minimum Efficient Scale (MES) is a quantity of production that an organization produces at the lowest cost possible. The lowest point on the long run average cost curve illustrates Minimum Efficient Scale. Minimum efficient scale helps business entities to produce goods or services at the lowest cost possible. The economists value it highly. This is because it is a point where the business is very efficient and effective in the use of resources. Minimum efficient scale is the scale whereby firms exploit internal economies of scale fully. It is an output range where an organization achieves productive efficiency. Minimum efficient scale comprises a range of output levels. It is where the constant returns to scale is realized. Furthermore, the cost of producing a unit of a service or a product is at its lowest. Minimum efficiency scale in a particular industry depends on the nature of costs of production. A firm that has high ratio of fixed to variable costs has the ability to reduce average cost through increased scale of output. This can result in concentrated market structure. Economies of scale can be a barrier to entry for the new firms. This results from achievement of cost advantages by existing firms. The firms with cost advantages undercut entering firms by lowering the prices of the goods or services they produced. Small market percentage do not allow for full utilization of economies of scale. This is brought about when many firms are able to attain MES. Many firms in the market cause a lot of competition to each other. In addition, with natural monopoly, the long run average cost curve falls over a huge range of output. This may enable one or two suppliers to utilize economies of scale available. Figure 1 The figure above illustrates the minimum efficient scale. The above firm can produce 5 items at the lowest cost possible. Arrow A (dotted) shows increasing returns to scale (Economies of scale) and Arrow B shows decreasing returns to scale (diseconomies of scale). Point C shows the MES. Determinants of minimum efficient scale There are many determinants of minimum efficient scale. They include empowered employees, better technology, container principle, quality raw materials, good location and low cost labor. Empowered employees are able to increase their productivity. Increased employee productivity leads to reduced cost of production. Employees are empowered through, specialization, training and motivation. Larger firms split production process into separate tasks. As a result, the employees become experts in their areas and learn to utilize their resources effectively. As result, losses and wastages are dramatically reduced. Reduced losses and wastages culminate to reduced production costs. Trained workforce enables the employees to acquire more skills and knowledge in the areas of their work. Trained employees increase the speed and accuracy of completing their tasks. As a result, more work is done within short time possible. The company is able to save money by reducing the length of working time especially where employees are paid on time basis. The employee can also be empowered through motivation. Motivated workers take pride in their work and work harder. The outcome is increased speed of production and quality of products produced. The second determinant of minimum efficient scale is better technology. A business entity that invests in better technologies reduces cost of production in the end. This is possible when the better technologies reduces energy consumption, produces good quality products faster and do multiple jobs. When good quality products are produced faster, time is saved. Machines that do multiple jobs reduce the number of employee working thus reduce the cost of production. Better machines and technologies reduce product waste and losses. The third determinant of minimum efficient scale is the container principle. The business enterprises that use large capacity containers to transport and store its products reduce associated costs because they benefit from economies of scale. Bulk transportation reduces transport per unit cost. Furthermore, a business entity that utilizes large storage containers reduces the overall transportation and storage costs. Fourthly, a business entity that uses good quality raw materials reduces their cost of production substantially. The business entities should always accept raw materials that are of high quality. This reduces the time wasted on rejected products as well as transportation costs that are incurred in returning and sourcing additional raw materials to replace the bad ones. The fifth determinant of minimum efficient scale is appropriate locations. Business entities that produce goods should choose location closer to the raw materials. Production cost are increased significantly by transportation costs. However, if a business entity set its factories near the raw materials, the transportation to the factory is significantly reduced. Consequently, reduced transportation cost lead to reduced cost of production. The sixth determinant of minimum efficient scale is use of cheap labour. Human resource and labour in organization is allocated a lot of money for salaries and wages. The business entity that produces in countries that salaries and wages are low is likely to produce its products and services at a lower cost. The extent to which the level of competition is dictated by minimum efficient Scale An organization that attains minimum efficient scale has Competitive Advantage over its rival organizations. Competive advantage is achieved when an organization offer greater value to consumers as compared to its competitors. Business entity desire to stay ahead of its competitors at all times to maintain market leadership. When the businesses decide to lower their prices, they may command large market share but the profitability reduces. There are various ways in which minimum efficient scale influence the level of competition. An organization that has utilized full economies of scale attains minimum efficient scale. The organization produces it products at a lower price as compared to its competitor. Therefore, the business is able to reduce the cost of production. The lower cost of production allows a business entity to lower the price of its goods and services. According to Katz and shepherd (2004), organizations can cope with competitive forces by using certain generic strategic approaches to outperform other firms. In this strategy, the firm with lower production cost attains cost leadership in the industry and can use the advantage to command large market share. The main objective of the strategy is to become the lowest cost producer. Firms achieve cost advantage by being efficient in operations, utilizing economies of scale, technological innovation, low cost labor and access to raw materials in a preferential manner. Incase numerous firms in an industry adopts cost leadership strategy or even if no firms faces cost disadvantage in implementing cost leadership strategy, then sustained competitive advantage for the business entities in the industry is lost. In order to generate sustained competitive advantage, the valuable cost leadership competitive strategy has to be rare and imitation has to be costly. A relationship exists between firm sizes and minimum efficient scale. This is measured according to the volume of production and costs. The measurement is done based on average costs per unit of production. When the average cost per unit of production is minimum, the optimal volume of production is attained. Low cost producer strategy produces positive results when a number of factors are considered. There is a direct relationship between the size of the market and minimum efficient scale. This is true when there is price wars, standard products, low level of differentiation, similar use of the product, low switching consumer cost and where buyers have significant power to influence market prices. First, markets where price wars are dominant make it possible for the minimum efficient scale to influence competition landscape. Business entities that have lower cost of production amass large market share because they are able to reduce the price of their goods and services. This is true especially in a market where customers are highly sensitive to price changes in the products and services they consume. Low cost producer strategy has competitive strength because it has the power to increase or reduce the price especially where competitors are charging higher prices. Cost leaders make it difficult for new rival businesses to enter their market. However, the new entrants may use different strategies to enter the market such as better quality or aggressive marketing. Secondly, minimum efficient scale influences competition where many companies produce similar goods or services. Business entities that produce similar goods and services suffer from high competition. The cost leader usually takes a large market share because the only difference existing between the business and other rival is the price. The cost leader is able to produce goods and services at lower cost thus set the prices lower. The cost leader must be careful not to be undercut by other similar business enterprises. When there is high rivalry, the cost leader focuses on two choices of pricing strategies. The first is where the cost leader price is equal to the price of the higher cost competitors. This helps in reducing likelihood of competitors imitating low cost firm. The second choice is where the low cost firm prices its products or services lower than that of high cost rivals. Customers will be attracted to the low cost firm because of low its prices. This will result in increase of market share and sales volume. Thirdly, minimum efficient scale influences markets that experience higher amount of substitute goods. The cost leader who maintains its products in an attractive manner in comparison to substitutes win large number of customers. To help retain customers, the low cost leader reduces prices and develop price value relationship. Fourthly, competition among business can be influenced by minimum efficient scale where buyers use the product in similar ways and the needs are same. This is true because the only thing that can differentiate different business entities is the prices they offer in the market. The fifth point that makes minimum efficient scale to influence competition is where low-switching costs is incurred by buyers when changing from one seller to another with better prices. Minimum efficient scale can influence competitive landscape that has large buyers with significant bargaining power. Powerful buyers can threaten firms through demand of low prices and better quality from their own suppliers. Under the above circumstances, business enterprises that have low cost are the only entities that may accept the demands of the buyers without significantly compromising their financial strength or profit. Finally, minimum efficient scale influence markets where suppliers of the raw materials posses monopolistic tendencies. Suppliers may increase the price of the materials they supply to business enterprise. Higher prices lock out business enterprises that have higher cost of production. However, the business entity that derives its cost leadership through efficient and effective production processes will afford to purchase the raw materials at a higher cost. Conclusion Minimum efficient scale is a point where a business or a firm experiences the lowest level of production cost. It is a production level that is popular to economist because the level suggests that the firm is using the resources effectively and efficiently to produce. Firms with the lowest production cost are able to withstand fierce competition and other problems that are price and cost related. They are also able to develop strong financial resource base because they make higher profits. When the companies lower prices for their goods and services due to competition, their profits automatically declines. Firms that incur higher production cost are worst affected by competition that force them to reduce the price of goods and services that they supply. There are various ways that firms can reduce its cost of production. They include use of empowered employees, adopting better production technologies, establishing factories near sources of raw materials, using cheaper labour and the of container principle. All the above reduces wastes and costs thus helping to lower the cost of production. References Katz, J, & Shepherd, D2004, Corporate entrepreneurship, Emerald Group Publishing, London. Barney, J1997, Gaining and Sustaining Competitive Advantage, Addison-Wesley, USA. Grant, R 1998, Contemporary Strategic Analysis, 3rd edition, Blackwell, USA.   Read More