Unit Costs Formula
The average cost per unit is calculated using:
Total production costs in given period
Total output in period (units)
Economies of Scale
- Arise when unit costs fall as output increases.
- This is important to a business because a lot of companies compete on price.
Internal vs External Economies of Scale
Internal - Arise from the increased output of the business itself.
External - Occur from within an industry.
Internal Economies of Scale
Buying Economies - Buying in greater quantities usually results in a lower price and large businesses have bigger negotiating powers.
Technical - Use of specialist equipment or processes to boost productivity.
Marketing - Spreading a fixed marketing spend over a larger range of products, markets and customers.
Network - Adding extra customers or users to a network that is already established.
Financial - Larger firms benefit from access to more and cheaper finance.
External Economies of Scale
- Arise from the industry as a whole so all competitiors benefit.
- Often associated with particular geographic areas.
- Having many specialist suppliers close by.
- Access to research and development facilities.
- Pool of skilled labour to choose from.
Diseconomies of Sale
This occurs when unit costs start to rise as output increases.
- More workers are needed if products are sold very quickly and this spreads more costs over all products.
- Managers lose control of looking over stores and checking profit/loss as companies get bigger.
- Pressure from the media can damage a business' reputation and lose customers which increases unit costs as production costs are spread over less customers.
Labour vs Capital Intensity
Unit costs are closely linked to the relationship between labour and capital in operations.
Labour Intensive - Production relies on using labour resources.
Capital Intensive - Production relies on using capital resources such as machinery.
Examples of Labour and Capital Intensive Industrie
Labour Intensive - Food processing, hotels and restaurants, fruit farming, hairdressing, coal mining.
Capital Intensive - Web hosting, car manufacturing, oil extraction and refining, intensive arable farming, transport infrastructure.
Implications of Resource Intensity for Unit Costs
Labour Intensive - Labour costs are higher than capital costs. Costs are mainly variable so there is a lower break even output. Firms benefit from access to sources of low-cost labour.
Capital Intensive - Capital costs are higher than labour costs. Costs are mainly fixed so there is a higher break even output. Firms benefit from access to low cost, long term financing.
Benefits of Labour Intensity
- Unit costs may still be low in low wage locations.
- Labour is a flexible resource through multi-skilling and training.
- Labour is at the heart of the production process which can help continuous improvement.
Drawbacks of Labour Intensity
- Risk of problems with employer-employee relations.
- Possible high costs of labour turnover with recruitment, training, etc.
- Need for a continuous investment in training.
Benefits of Capital Intensity
- Greater opportunities for economies of scale.
- Potential for significantly better productivity.
- Better quality and speed depending on the product.
- Lower labour costs.
Drawbacks of Capital Intensity
- Significant investment needed for machinery.
- Potential for loss of competitiveness due to obsolescence.
- Possible resistance from staff due to change from labour force.