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Difficulty: HardScales of Production and Economies of Scale

A cement manufacturing company located in Calabar doubles all of its productive inputs, leading to a decline in its long-run average cost (LRACLRAC) up to a specific output level, after which administrative delays and coordination problems cause its LRACLRAC to rise. At the same time, all cement producers in the industrial zone experience a reduction in raw material transport costs following the state government's construction of a dedicated freight rail network. Which of the following correctly identifies the cost advantage derived from the freight rail network and the cost disadvantage caused by administrative delays?

  1. External economy of scale for the transport cost reduction and internal diseconomy of scale for administrative delaysAnswer
  2. B
    Internal economy of scale for the transport cost reduction and external diseconomy of scale for administrative delays
  3. C
    External economy of scale for the transport cost reduction and the law of diminishing returns for administrative delays
  4. D
    Internal economy of scale for the transport cost reduction and short-run fixed cost allocation for administrative delays

Answer

External economy of scale for the transport cost reduction and internal diseconomy of scale for administrative delays
The reduction in transport costs benefits all producers in the industrial area due to public infrastructure development outside the direct control of any individual enterprise, which constitutes an external economy of scale. Conversely, administrative bottlenecks and communication breakdown within the firm as it doubles all production inputs constitute an internal diseconomy of scale.

Step-by-Step Solution

1
Analyze the cost advantage resulting from the new freight rail network constructed by the state government.
Since the rail network reduces transport costs for all cement producers in the industrial zone regardless of individual firm expansion, it represents an external economy of scale (external technical/commercial economy).
External economies of scale are cost-saving benefits enjoyed by all firms within an industry due to external developments, such as regional infrastructure improvements or industry localization.
2
Analyze the cost disadvantage caused by administrative delays within the growing firm.
Because administrative delays arise from managerial bottlenecks and communication failure as the firm doubles all inputs, this unit cost increase represents an internal diseconomy of scale.
Internal diseconomies of scale occur within a specific firm in the long run when excessive expansion leads to managerial inefficiencies, bureaucratization, and loss of effective control.
3
Differentiate long-run scale concepts from short-run concepts.
The scenario specifies that the firm doubles all inputs, confirming long-run scale adjustments rather than short-run variation of a single input under the law of diminishing returns.
Scale effects evaluate variations in unit cost when all factors of production are expanded simultaneously.

Key Concept

Internal and External Economies and Diseconomies of Scale
Estimated Time:2m 0s
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Topics

Scales of Production and Economies of Scale

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