industrial organization In economics, industrial organization is a field that builds on the theory of the firm by examining the structure of (and, therefore, the boundaries between) firms and markets. Industrial organization adds real-world complications to the perf ...

, the minimum efficient scale (MES) or efficient scale of production is the lowest point where the plant (or firm) can produce such that its

long run average cost In economics, a cost curve is a graph of the costs of production as a function of total quantity produced. In a free market economy A market economy is an economic system in which the decisions regarding investment, production and distributi ...

s are minimized. It is also the point at which the firm can achieve necessary economies of scale for it to compete effectively within the market. Minimum-efficient-scale

Measurement of the MES

Economies of scale In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of time. A decrease in cost per unit of output enables ...

refers to the cost advantage arise from increasing amount of production. Mathematically, it is a situation in which the firm can double its output for less than doubling the cost, which brings cost advantages. Usually, economies of scale can be represented in connection with a cost-production elasticity, ''Ec''. :

Ec = \frac.

The cost-production elasticity equation can be rewritten to express the relationship between marginal cost and average cost. :

Ec = \frac = \frac = Marginal Cost(MC)/Average Cost(AC)

The minimum efficient scale can be computed by equating

average cost In economics, average cost or unit cost is equal to total cost (TC) divided by the number of units of a good produced (the output Q): AC=\frac. Average cost has strong implication to how firms will choose to price their commodities. Firms’ sale ...

(AC) with

marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it r ...

(MC).i.e.

Ec = MC / AC = 1.

. The rationale behind this is that if a firm were to produce a small number of units, its average cost per unit would be high because the bulk of the costs would come from

fixed cost In accounting and economics, 'fixed costs', also known as indirect costs or overhead costs, are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be recurring, such as interest or r ...

s. But if the firm produces more units, the average cost incurred per unit will be lower as the fixed costs are spread over a larger number of units; the marginal cost is below the average cost, pulling the latter down. The efficient scale of production is then reached when the average cost is at its minimum and therefore the same as the marginal cost.

Relationship to market structure

The concept of minimum efficient scale is useful in determining the likely

market structure Market structure, in economics, depicts how firms are differentiated and categorised based on the types of goods they sell (homogeneous/heterogeneous) and how their operations are affected by external factors and elements. Market structure makes it ...

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. However, if the minimum efficient scale can only be achieved at a significantly high levels of output relative to the overall size of the market, the number of firms will be small, the market is likely to be a

oligopoly An oligopoly (from Greek ὀλίγος, ''oligos'' "few" and πωλεῖν, ''polein'' "to sell") is a market structure in which a market or industry is dominated by a small number of large sellers or producers. Oligopolies often result from ...

monopoly A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...

market.

MES in L-shaped cost curve

Modern cost theory and recent empirical studies suggest that, instead of a U-shaped curve due to the presence of diseconomies of scale, the

curve is more likely to be L-shaped. In the L-shaped cost curve, the long run cost would keep fixed with a significantly increased scale of output once the firm reaches the minimum efficient scale (MES). However, the average cost in an L-shaped curve may further decrease even though most economies of scale have been exploited when firms achieve the MES because of technical and production economies. For instance, the firm may obtain further economies of scale from skill improvement by training the employees, decentralization in management. Secondly, repair cost and scrap rate will decrease when the firm reaches a certain size. Thirdly, improvement in the firm's

vertical integration In microeconomics, management and international political economy, vertical integration is a term that describes the arrangement in which the supply chain of a company is integrated and owned by that company. Usually each member of the suppl ...

, producing by a firm itself some of the materials and equipment it needs at a lower cost for its production process instead of buying them from other firms.

References

{{reflist Microeconomics Industrial organization Costs

Measurement of the MES

Relationship to market structure

MES in L-shaped cost curve

See also

References