Minimum efficient scale
Investopedia Financial Dictionary:
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Minimum Efficient Scale
The smallest amount of production a company can achieve while still taking full advantage of economies of scale with regards to supplies and costs. In classical economics, the minimum efficient scale is defined as the lowest production point at which long-run total average costs (LRATC) are minimized.
The minimum efficient scale may be expressed as a range of production values, but its relationship to the total market size or demand will determine how many competitors can effectively operate in the market.
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If the minimum efficient scale is relatively small compared to total market size (a good example would be computer software), many companies can exist in the same space. In other industries - such as telecom and basic materials - the minimum efficiency scale is quite large due to the high ratio of fixed costs to variable costs. In these types of industries, only a few major players tend to dominate the space.
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Minimum efficient scale
Oxford Dictionary of Social Sciences:
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Minimum Efficient Scale
Refers to the least quantity that can be produced in a cost-minimizing way. For example, a factory may produce most cheaply at full capacity, so that any level of production using less than one factory would not be efficient. But two factories could produce larger quantities equally cheaply.
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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.
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Contents
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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
- ^ Carlton D. and Perloff M.: "Modern Industrial Organization" Fourth Edition, 2005
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