Unit Costs and Efficiency

Topics covered in this are:

  • Unit Costs
  • Economies of Scale (Internal and External)
  • Labour intensive production methods and benefits and drawbacks
  • Capital intensive production methods and benefits and drawbacks
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  • Created by: GeorgeB16
  • Created on: 30-01-16 12:33

Unit Costs Formula

The average cost per unit is calculated using:

Total production costs in given period

---------------------------------------------------------------

Total output in period (units)

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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.
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Internal vs External Economies of Scale

Internal - Arise from the increased output of the business itself.

External - Occur from within an industry.

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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.

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External Economies of Scale

  • Arise from the industry as a whole so all competitiors benefit.
  • Often associated with particular geographic areas.
  • Examples:
    • Having many specialist suppliers close by.
    • Access to research and development facilities.
    • Pool of skilled labour to choose from.
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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.
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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.

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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.

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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.

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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. 
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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.
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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.
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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.
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