Download Economies of Scope and the Learning Curve

Economies of Scope and the
Learning Curve
Outline
1. What are economies of scope?
2. Measuring economies of scope
3. Real world examples
4. The learning curve
5. Source of learning
6. Cost and profit maximization
7. The shut down rule
Economies of Scope
If a single firm can jointly produce
goods X and Y more cheaply that any
combination of firms could produce them
separately, then the production of X and Y
is characterized by economies of scope
This is an extension of the concept of
economies of scale to the multi product
case
Economies of scope can be measured by as
follows:
C (Q1 )  C (Q2 )  C (Q1 , Q2 )
SC 
C (Q1 )  C (Q2 )
Where C(Q1,Q2) is the cost of jointly producing goods 1
and 2 in the respective quantities; C(Q1) is is the cost of
producing good 1 alone, and similarly for C(Q2).
Example: Let C(Q1) = $12 million; C(Q2) = $8 million;
and C(Q1,Q2) = $17 million. Thus:
$12  $8  $17 $3
SC 

 .15
$12  $8
$20
Thus joint production of goods 1 and 2 would result in a 15
percent reduction in total costs
Economies of scope arise from
“complementarities” in the
production or distribution of
distinct goods or services
Real world examples
Economies of scope between cable TV and high speed
internet service.
Production of timber and particle board.
Corn and ethanol production
Production of beef and hides.
Power generation and distribution
Joint cargo and passenger transportation in airlines
reduces excess capacity.
Global wholesale distribution of cheese, salad dressing,
and cigarettes (example: Phillip-Morris-Kraft).
Computer aided design of (CAD) of aircraft
components.
The Learning Curve
The learning curve embodies
the (inverse) relationship
between average production
cost and cumulative output.
Over
1,000,000,000,000,000
sold
We should have
this figured out by
now
Sources of learning
•The experience of the workforce tends to
increase with cumulative output—thus workers
are more familiar with the production process
and have their movements/activities become
routinized or a matter of habit.
•There are usually several ways to do a task, and
it takes time and experimentation to find the best
way.
•Quality control for inputs and outputs needs
time to identify potential problem areas.
•Input suppliers have their owning learning
process
Figure 7.6a
Average Cost
Example: Texas
Instruments pushed
calculator prices from
about $1,000 to around
$10 in the 1970s.
Learning curve
Cumulative Output
Average cost is a decreasing function
of cumulative output
Figure 7.6b
Average Cost
Learning is manifested by
a downward shift of the
LAC function
LAC (year 1)
Increasing
returns
Learning
LAC (year 2)
1,000
1,500
Rate of Output (per Month)
Figure7.7 Costs and Profit-Maximization: The single product
case
Dollars per Unit of Output
Demand '
AC
MR'
P¡

P*
AC

MC
Demand
MR
Q¡ Q*
Qmin
Q'
Output
Green-shaded area is economic
profit
Figure 7.8 Loss Minimization Means producing
Some Output
Dollars per Unit of Output
MC

P*



AC
AVC

Marginal
revenue
Q*
Demand
Output
Summary
If the firm shuts down production, then losses will be
equal to fixed cost, or:
Losses = 
If the firm supplies Q* units at the price P*, then:
Losses = P*
Moral of the story: So long as price (average
revenue) exceeds average variable cost, the loss
minimizing strategy will entail producing some
output.