Minimum efficient scale

Minimum efficient scale

Minimum efficient scale (MES) 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.

Contents

Computing

Mathematically, the efficient scale can be computed by either taking the first order derivative of the Average Cost (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 Cost (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.

Relationship to market structure

This concept is useful in determining the likely market structure 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. [1]

References

  1. ^ Carlton D. and Perloff M.: "Modern Industrial Organization" Fourth Edition, 2005

See also


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