6. Costs of Production - The Business Guys

LCEconomicswww.thebusinessguys.ie©

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CostsofProduc:onMrTraynor©

EconomicsNote6•LeavingCert•5thYear

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JonathanTraynor


Introduc)onInlaterhoundoutswewilldiscussmarketstructures.Marketstructuresiden:fythedifferenttypesoffirmsthatcanexistinaneconomy.Itisimportanttorememberthat,intheory,thecostsofproduc:on,whatwearestudyingnow,arethesameforanytypeoffirmthatcanexistinaneconomy.Whileeachfirmfacesdifferentnumericalcosts,thetheorybehindthesecostsisthesameforallfirmsinaneconomy.

E.g.Rent,Loanrepaymentsetc.

IfIbuyacomputerfactory,Iwillhavetogetaloanfromthebanktoprovidemewiththenecessarymoneytopurchasethatfactory.TheseloanrepaymentsareafixedcostasIhavetogivethebankasetorfixedamountofmoneyeverymonth.E.g.myloanrepaymentsare€10,000permonth.WhetherIproduceamillioncomputerspermonthornone,Is:llhavetopaythebankthis€10,000.

ThereforethisloanrepaymentdoesnotchangewiththeamountofoutputIproduceandassuchisanexampleofafixedcost.

FixedCostsCurve

FixedCosts:arecoststhatremainthesameirrespec:veofthelevelofoutput.

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Costs(€)

Quan:ty

€10,000

10 1,000

FC


Thegraphoverleafshowsthatfixedcostsdonotchangeasoutputchangesandassuchisahorizontalline.WhetherIproduce10unitsor1,000units,myfixedcostsremainconstantat€10,000.

E.g.Electricitycosts,inputcosts,labour.

Stayingwiththecomputerfactoryexample,ifIamcurrentlyproducing1,000computerspermonthandIwishtoproduce2,000computersmonth,Ihavetobuymoreplas:candmicrochips,Ihavetokeepthefactoryopenlongerandassuchusemoreelectricitytopowerthemachinesandlightsetc,andIhavetopaymyworkersmoreastheyareworkinglongerorhirenewworkerswhichagaincausesmywagebilltoincrease.

Therefore,asoutputexpandsVariableCostsrises.

AsoutputfallsVariableCostsfall.

VariableCosts

VariableCosts:arecoststhatchangethatoutputchanges

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Costs(€)

Quan:ty

VC

€100

€10

10 100


Thegraphoverleafshowsthatvariablecostschangeasoutputchanges.

Itisimportanttonotethatat0output,variablecostsare0.

Asoutputrisesvariablecostsriseandasoutputfallsvariablecostsfall.

Aswemovefromproducing10unitstoproducing100unitsourvariablecostshavechangedfrom€10to€100.Anincreaseinoutputcausesanincreaseinvariablecosts.

Butconversely,ifwemovefromproducing100unitstoproducing10unitsourvariablecostsfallfrom€100to€10.Adecreaseinoutputcausesadecreaseinvariablecosts.

TotalCostsissimplytheaddi:onofFixedCostsandVariableCosts.

Let’stakeanotherlookatourfixedandvariablecostcurves.

Ifweaddthetwocurvesabovewegetthecurveoverleaf.

TotalCosts:Istheen:recostofproduc:onfacedbythefirm

Mathema:callyTC=FC+VC

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FixedCosts VariableCosts

Costs(€)

Quan:ty

Costs(€)

Quan:ty

F.C.

V.C.


Thegraphaboveshowstheaddi:onofFixedCostsandVariableCosts.Inourdefini:onforTotalCostswesaidthat

TC=FC+VC

Therefore,ifweslightlychangethegraphabovewegetourgraphforTotalCosts.

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Costs(€)

Quan:ty

VC

FC

Costs(€)

Quan:ty

TC

TotalCostsCurve


AverageFixedCosts

ItiscalculatedbydividingFixedcostsbyoutput(quan:ty).

AverageFixedCostsCurve

ThegraphaboveshowsthatAFCfallssteeplyatthestartandthenbeginstoflacen.Itcon:nuestofallasoutputincreasesbutatanincreasinglyslowerrate.

Thisisduetothefactthat,asincreasingamountsofoutputareproduced,fixedcostsarebeingspreadoveragreaterrangeofoutput.

AFCcanneverreachzero.

RememberAverageFixedCostsiscalculatedbydividingFixedCostsbyquan:ty.

AverageFixedCosts(AFC):arethefixedcostsperunitofoutput.

Mathema:cally

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AFC=FCQ

Costs(€)

Quan:ty

AFC

!


Goingbacktothecomputerfactoryexample,ourfixedcostswere€10,000.Seethetablebelow.

WecanseefromthetableabovethatAFCfallssteeplyini:allyandthenitsreduc:ongetssmallerandsmallerasoutputincreases.

RememberFixedCostsisanumberthatdoesnotchange.TocomputeAFCyoudividefixedcosts(aconstant)byoutput,q,(anumberthatisgeengbigger)

Therefore,asQrisesandfixedcostsremainsthesame,AFCmustfall.

AverageVariableCosts

AverageVariableCostsarecalculatedbydividingVariablecostsbyoutput.

AverageFixedCosts

Quan:tyofOutput FixedCostsAverageFixedCosts

(AFC)

1 €10,000 €10000.00

2 €10,000 €5000.00

3 €10,000 €3333.33

4 €10,000 €2500.00

5 €10,000 €2000.00

6 €10,000 €1666.67

7 €10,000 €1428.57

8 €10,000 €1250.00

9 €10,000 €1111.11

10 €10,000 €1000.00

AverageVariableCosts(AFC):arethevariablecostsperunitofoutput.

Mathema:cally

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AVC=VCQ


Beforewehavealookatanumericalexample,wewillquicklydiscussMarginalPhysicalProduct.

Wewillcoverthisconceptinmuchgreaterdetailinalaterhandout,butfornowallitis,istheextraamountofoutputthatismadefromhiringanextraworker.

E.g.Ifthetotalamountofoutputthatafirmproducesinaweekis100computersandtheyhireanextraworkerandnowtheiroutputis110computersperweek.InthiscasetheMPPistheextra10computersthattheextraworkerwasresponsibleforproducing.

Nowlet’slookatanumericalexample.Againlet’sconsiderthecomputerfactoryexamplewhichpaysitsemployees€1000perweekandfurthermoreweassumethatthisfirmhasnootherVariableCosts.(Thisisasimplifica:onbutisusefulforouranalysis)

PointstoNote

1) Thefirstworkerproduces6computers.

2) Thesecondworkeraddsmoretototaloutputthanthefirstworker.

MarginalPhysicalProduct(MPP):istheextraoutputthatisgeneratedbyemployinganextraunitofafactorofproduc:on.

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NumberofWorkers

VariableCosts(Weekly)

TotalOutput(Computers)

MarginalPhysical

Product(MPP)

Outputperworker

AverageVariableCost

(AVC)

1 €1,000 6 - 6 €166.67

2 €2,000 16 10 8 €125.00

3 €3,000 31 15 10.3333333333333 €96.77

4 €4,000 56 25 14 €71.43

5 €5,000 86 30 17.2 €58.14

6 €6,000 106 20 17.6666666666667 €56.60

7 €7,000 124 18 17.7142857142857 €56.45

8 €8,000 140 16 17.5 €57.14

9 €9,000 154 14 17.1111111111111 €58.44

10 €10,000 166 12 16.6 €60.24


3) TheMPPofthethirdworkeris15computers,whichisgreaterthattheMPPofthesecondworker,10computers.

Uptoandincludingthefilhworker,theextraoutputproducedbyeachextraworker(MPP)isincreasing.Thisisduetotheincreasedspecialisa:onoflabour.Howeveralerthefilhworker,theMPPofeachworkerislessthantheworkerprevious.ThisisduetotheLawofDiminishingMarginalReturns.

AverageVariableCostCurve

ThegraphaboveshowsthatAVCfallsini:allyandthenrisesquicklyasgreaterquan::esofoutputareproduced.Itslopesdownwardduetotheincreaseinthedegreeofthespecialisa:onoflabour(helpsreducecost

TheLawofDiminishingMarginalReturns:statesthatasextraunitsofavariablefactorofproduc:onareaddedtoasetsizedfixedfactorofproduc:on,eventuallyapointwillbereachedwhentheextraoutputcausedbythelastunitofthevariablefactoremployedbeginstodecline.

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Costs(€)

Quan:ty

AVC!


perunit)andslopesupwardsagainduetoincreasingVCperunitbecauseoftheLawofDiminishingMarginalReturns.

AverageTotalCostsAverageTotalCostsisinvariablyreferredtoasAverageCostandassuchIwilladoptthatconven:onfortherestofthesenotes.

Ifwetakethefirstformulaforcalcula:ngAC,weseethatitissimplytheaddi:onofAFCandAVC.

Ifwedrawthesedifferentcurvesseparatelyonthesamegraphwegetwhatweseebelow.

CostCurves

Now,ifwecombinethetwocurveswegettheAverageCostCurve.

AverageCost(AC):aretotalcostsperunitofoutput.

Mathema:cally1)AC=FC+VC

or

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AC= TCQ

2)

Costs(€)

Quan:ty

!!

AFC

AVC


AverageCostCurve

WecanseefromthediagramthattheAverageCost(AC)curveisU-shapedbutitisnecessarytounderstandwhythiscurveisU-shaped.

ShapeoftheAverageCostCurveAverageCostismadeupofAverageFixedCostandAverageVariableCost

AC=AFC+AVC

TheACcurveisU-shapedforthefollowingreasons

TheACcurveini:allyslopesdowndueto

1) TheSpreadingoutofFixedCostsoveraGreaterRangeofOutput.

2) TheIncreasedSpecialisa:onofLabour:Asafirmincreasesoutputithiresmorestaff.Asextrastaffarehiredeachmemberofstaffdoesonespecificjob.Thatis,theyspecializeinonetypeofwork.Thisincreasestheefficiencyoftheproduc:onprocessandassuchmanifestsitselfasareduc:onincosts.


Costs(€)

Quan:ty

!

AC


TheAverageCost(AC)curveslopesupwardsagaindueto

1) TheLawofDiminishingMarginalReturns:Asmoreandmoreworkersareaddedtoafactory,eventuallytheextraoutputcausedbyeachextraworkerfalls.Thecompanyispayingthesameamountofmoneyforlessworkbeingdone.ThismanifestsitselfasanincreaseincostsandcausestheACcurvetoslopeupwards.

Eventhoughitmaynotbeexplicitlyobvious,theAverageCostcurveisameasureoftheefficiencyofproduc:onforthefirm.Thecheaperafirmcanproduceeachproduct,themoreefficientthatfirmis.Thisisthedefini:onortheyards:ckwithwhicheconomistsusetoefficiency.

MarginalCost

WheretheGreeklecer∆(pronounced“Delta”),represents“thechangein”avariable.

E.g.IftheTCofproducing100computersis€20,000.IftheTCofproducing101computersis€20,500themarginalcostofthe101stcomputeris

€20,500-€20,000=€500

MC=€500

MarginalCost(MC):istheaddi:ontoTotalCostasaresultofproducingoneextraunitofoutput

Mathema:cally1)MC=TC2-TC1

or


MC=∆TC∆Q

2)


MarginalCostCurve

Explana)onTheMarginalCostcurveslopesdownwardini:allyduetotheextrareturnsfromincreasingspecialisa:onoflabourandthenbeginstoriseagainduetoTheLawofDiminishingMarginalReturns.


Costs(€)

Quan:ty

!MC


TheRela)onshipbetweenMarginalCostandAverageCost

IfyoulookatthegraphaboveyouwillseethatwhenMCislessthanAC,ACisfalling.WhenMCisgreaterthanAC,ACisrising.Wheretheycross,MC=AC.

1) WhenMC<AC,thenACisFalling

2) WhenMC>AC,thenACisRising

3) WhenMC=AC,thenACisataMinimum

TheMarginalCost(MC)curvecrossestheAverageCost(AC)curveattheminimumpointoftheAverageCost(AC)curve.

Thisisbecauseatlowlevelsofoutput,MCisbelowACcausingACtofall.But,alerthetwocurvescross,MCrisesaboveAC.ForthisreasonACmuststarttoriseagain.

Hencethispointofintersec:on(MC=AC)istheminimumpointoftheACcurve.


Costs(€)

Quan:ty

MC

!

AC!

PointofIntersec:onMC=AC


TheShortRunandtheLongRunSofarallofthecostcurvesthatwehavebeendiscussinghavebeeninwhatiscalledtheshortrun.

Theideahereisthatafirmcannotchangeeverythingabouthowitdoesbusinessquickly.Thatisitcannotchangethesizeofitsfactory,whereitislocated,thenumberofmachinesithas,whatitproducesovernight.Somefactorsofproduc:ontakealong:metochange.

Soifacomputerfirmlooksatallitsproduc:onprocessesandbelievesthatitwilltakefiveyearstochangeeverythingabouthowitdoesbusiness,thenit’sshortrunisfiveyearslong.

Remember,theShortRunisaperiodof:mewhereatleastonefactorofproduc:onisheldfixedorconstant.

Thefactorofproduc:onthattakesthelongest:metochangeisusuallyitsFixedCapital.

E.g.Buildings,machinesetc.

ThereforetheShortRunisusuallytheperiodof:meittakesacompanytochangeitsquan:tyofcapitalstock.

Also,theShortRunisspecifictoeachdifferentcompany.ForourcomputercompanytheShortRunwasfiveyearslong.Howeverforahotdogvendor,hecouldbuyanewhotdogcartinthreemonthsorso.SohisSRisthreemonths.

Anyamountof:melongerthantheshortrunentersintotheLongRun.

IntheLongRuneveryfactorofproduc:onisvariable.Thesizeofthefactory,thenumberofmachinesetc.

Therefore,ifeveryfactorofproduc:onisvariableintheLR,therearenoFixedcostsintheLR.

Hereiswherewerunintoaproblem.WehavejustsaidthattherearenoFixedCostsintheLR.Butatevery:methatthefirmisproducing,italwaysfacesfixedcosts.SohowcantheLRevenexist?

Inprac:cewesaythattheLRisaseriesofconsecu:veshortruns.Theanalogybelowshouldhelpexplain.

TheShortRun(SR):isaperiodof:mewhereatleastonefactorofproduc:onisheldconstant.

TheLongRun(LR):isaperiodof:melongenoughforallfactorsofproduc:ontobevariable.



Wegobacktothefactorywherewewereproducingcomputers.Thisfactoryisabuildingwhichisfixedinsizeandthequan:tyofmachinesisalsofixed.Thereforeweareintheshortrunasatleastonefactorofproduc:on(Capital)isheldconstant.(ShortRun1).Assalesincreasewestarttohiremoreworkersbutaswedo,eventuallytheLawofDiminishingMarginalReturnssetsinwhichcausesourACcurvetorise.Atsomepointwemustmovetoalargerfactoryandbuymoremachinerytoaccommodateourextraworkersandassuchmakethemmoreefficient.Sowemovetoalargerfactory,buymoremachinesandstartagain(ShortRun2).

Againassalesincreasewehiremoreworkers,theLawofDiminishingMarginalReturnssetsin,ACrisesandwemovetoabiggerfactory,buymoremachinesandstartagain(ShortRun3).

Thiswholeprocesscon:nuesatinfini:umun:lthefirmcloses.

Therefore,ifweputallourShortRunAverageCost(SRAC)curvesinsequencewegettheLongRunAverageCost(LRAC)curves.

TheLongRunAverageCostCurve(LRAC)


Costs(€)

Quan:ty

!

!

!

!

!

!

SRAC1

SRAC2

SRAC3

SRAC4SRAC5

SRAC6

LRAC

EconomiesofScale DiseconomiesofScale


TheShapeoftheLongRunAverageCostCurveFromtheabovediagramwecanseethatbyjoiningallofthelowestpointsoneachoftheSRACcurveswegettheLRACcurve.

AgainitisU-shaped.Itslopesdownatthestartduetoeconomiesofscaleandthenslopesupwardsduetodiseconomiesofscale.

ECONOMIESOFSCALE

TheseEconomiesofScalecanbeeitherInternalorExternal

Inotherwordstheinternaleconomiesofscalerepresenttheinternaladvantagestothefirmoflargescaleproduc:on.

INTERNALECONOMIESOFSCALE

1. IncreasedUseofSpecialisedMachinery:Afirmmaybeabletobuyorusemorespecialisedequipmentormachineryresul:nginareduc:oninunitcostsofproduc:on.

2. Construc)onEconomies:Largeplantscostlesspercubicfootthansmallerones.E.g.IffactoryAistwicethesizeoffactoryB,itdoesn’tmeanthatfactoryAcosttwiceasmuchtobuildasfactoryB.

3. EconomiesintheuseofLabour:Ifapar:cularjobcanbeseparatedintoseparateanddis:nctcomponentsitmayresultinareduc:onincosts.Alargefirmismorelikelytohavespecializedworkersforspecializedjobs.Thismeansworkersskillincreases.Therefore,outputisincreasedandthecostperunitofoutputfalls.

4. IndivisibilityProblemReduced:Ifthevolumeofproduc:onincreasestheunitcostmaybelowere.g.glass-makingfurnacesmayoperatearoundtheclocktosavecostsofcoolingandre-hea:ng.

EconomiesofScale:aretheforcesatworkwhichresultinareduc:onoftheLongRunAverageCosts(LRAC)ofproduc:onasthefirmorindustryexpandsinsize.

InternalEconomiesofScale:areforceswithinafirmwhichcausetheaverage/unitcostsofthatfirmtodeclineasthefirmgrowsinsize.



5. Produc)onProcessEconomies:Alargefirmmaybeabletorunoneprocessintothenextwithoutcostlydiscon:nui:es.e.g.asupermarketcouldhaveitsownbakery;whereasasmallnewsagentwouldhavetobuybreadfromabakery,thusincreasingcosts.

6. EconomiesintheuseofRawMaterials:Thebiggerthefirmthewidertherangeofproducts.Ifarawmaterialdoesn’tneedtobeusedinonesec:on,itcanbeusedinanother.

7. FinancialEconomies:Largerfirmsmayavailoflowerinterestratesfromfinancialins:tu:ons.Alsolargerfirmshaveabecerchanceofacquiringaloan.

8. PurchasingEconomies:Largefirmsaremorelikelytosecurefavourabletradingtermsastheybuyinbulk.Largerquan::esboughtmayresultinbiggerdiscounts

9. EconomiesinDistribu)on:Afirmwithahighvolumeofsalescanorganizeamoreefficienttransportanddistribu:onsystemthanasmallfirmwithonlyafewdeliveriestomake.Thisresultsinlowerunitcostofdelivery.

10.Marke)ngEconomies:Biggerfirmshavebiggeradver:singcampaigns.Thisresultsinsavingsinthecostofadver:singe.g.NIKEadver:singgloballyandassuchit’sadver:singcostsperunitarelowerastheyproduceahighervolumeofgoods.

11.ManagerialEconomies:Asafirmgrows,managementcostsmaynotgrowinpropor:ontothegrowthinthefirm.



Whileinternaleconomiesofscalerefertowhathappenswithintheindividualfirm,externaleconomiesaretheadvantagesoflargescaleproduc:onwhicharecommontoallfirmsintheindustry.

EXTERNALECONOMIESOFSCALE

1) BeVerinfrastructure:Asroads/communica:onsetc.improvetheywillbenefitallfirms.

2) BulkPurchasingofRawMaterialsbytheIndustry:Asanindustryexpandsfirmsrequiremorematerials/components.Thesemaybecomecheaperassuppliersexpandtomeettheincreaseindemand.

3) DevelopmentofSpecialistFirms:Someofthejobs,whichafirmonceperformedmaybe,contractedouttospecialistfirmsatreducedcostse.g.thesupplyoflinentohotels.

4) DevelopmentofseparateR&Dunits:AsindustrybecomesverylargeR&Dagenciesmaysetuptoprovidefacili:esforindividualfirms/ThecostsofresearchmaybesharedbetweenfirmsorwithapublicbodylikeTeagasc.

5) SuppliersofMachinery:Manufacturersofmachinerywillbeencouragedtodesign,developandproducemachinesforexpandingindustry.Theseadvancedmachineswillhelpreducecosts.

6) DevelopmentofTrainingCourses:WorkersinexpandingindustriesmaybeprovidedwithtrainingcoursesbyVEC’s,FÁShelpingthembecomemoreefficient.

7) SupportsfromPublicBodies:Somepublicbodieshelppar:cularindustriesingenerale.g.BordFailte/FASmayhelpsuchfirmsinthetourismindustry.

8) SubsidiaryTradesmaydevelop:Asanindustrygrowssubsidiarytradesmaydeveloptoservicetheexpandingindustrye.g.Hotels,B&B’sloca:ngclosetoairports,seaports

DISECONOMIESOFSCALE

ExternalEconomiesofScale:Theseareforcesoutsideafirmwhichcausetheaveragecostsofproduc:onofthatfirmtodeclineastheindustrygrowsinsize.



TheseDiseconomiescanbeeitherInternalorExternal

Inotherwords,theyarethedisadvantageswithinthefirmoflargescaleproduc:on.

INTERNALDISECONOMIESOFSCALE

1. ManagerialDiseconomies:Thebiggerthefirm,theharderitistomanage.Thedirectorsofthefirmareasmallgroupofpeoplewhomaynotknowallthenecessaryinforma:onwhichleadstocommunica:onproblems.

2. AsaFirmexpands,theinterestofworkersandmanagementmayconflict:Workersmayfeellikeacoginthewheelofproduc:on.

3. Specialisa)onofLabour:Althoughjobspecialisa:onensuresthatworkersbecomebecerattheirjob,itmaymeanthatworkersbecomeboredwiththeconstantrepe::onofthesametasks.

4. Higherpropor)onofNon-Produc)veworkers:Asthefirmgrowsinsizeitwillemployfull:meaccountantsandsolicitorsetc.Theseworkersarenecessarybutdonotincreaseoutput.Thisisnotwherethefirmgetsitsmoney.

5. UnreasonableWorkerDemands:Workersmayfeelthat,duetothesizeofthefirm,theyarebecerabletoincreasewagestounreasonablelevels.

DiseconomiesofScale:AretheforcesatwhichresultinanincreaseintheAverageCostofproduc:onasthefirmorindustryincreasesitssizeofopera:on.

InternalDiseconomiesofScale:AretheforcesatworkwithinafirmwhichcausetheAverageCostofproduc:ontoriseagainoncethefirmreachesacertainsize.



EXTERNELDISECONOMIESOFSCALE

Inotherwords,theyarethedisadvantagesoflargescaleproduc:oncommontoallfirmsintheindustry.

1. Increaseddemandforrawmaterials:Asdemandrises,pricerisesthusincreasingcoststothefirm.Inferiorgoodsmaybeusedalso.

2. IncreaseddemandforLabour:Skilledlabourbecomesshortinsupplycausingwagestorise.Thefirmmaybeforcedtoemploylessskilledworkers.Eitherway,costswillrise.

3. GreaterneedforInfrastructure:Asanindustryexpands,greaterdemandsaremadeontheeconomy’sinfrastructure.Thecurrentmaybeinadequateforthedemandsbeingmade.

Assump)onsunderlyingtheLawofDiminishingMarginalReturns

1) TechnologyRemainsConstant:TheLDMRassumesthattherearenoadvancementsintechnologyduringtheproduc:onprocess.Ifatechnologicalbreakthroughdoesoccur,theLawbeginsagainfromthestart.

2) ConstantQuality:ThelawalsoassumesthatthequalityoftheVariableFactorsthatarebeingaddedtothesetsizedFixedfactoraretheexactsameastheonesthatwerepreviouslyadded.i.e.Eachworkerisoftheexactsameskillandeduca:onlevel.

3) AllFactors:TheLDMRappliestoallfactors

4) OneFixedFactor:ThisLawassumesthatatleastoneFactorisfixed.Itonlyappliesintheshortrunandvariesfrombusinesstobusinessandfromindustrytoindustry.

ExternalDiseconomiesofScale:Aretheforcesatwork,outsideafirm,whichcauseAverageCoststoriseastheindustryexpandsinsize.Thesearecommontoallfirmsintheindustry



DiscusstheEconomicAdvantagesofFallingCostsofProduc)onfortheIrishEconomy.

1) IncreasedCompe))veness:WithlowercostspricesmayfallforIrishgoodsandexportsmaybecomecheaper.

2) LowerPrices:Withlowerpricesinfla:onmayfallandthismayen:ceconsumerstopurchasemoregoods.

3) IncreasedDemand:Businessesmayhaveincreaseddemandresul:nginincreasedsales,profitsandamoresecurefuture.Taxrevenuetothegovernmentmayalsoincrease.

4) IncreasedEmployment:Withrisingdemandbusinessesmayincreasetheirdemandforlabour/maintainexis:nglabour.

5) AVractInvestment/ImproveInterna)onalReputa)on:LowercostsforbusinesseswillencourageexpansionandacractforeignfirmsintoIreland.

6) ProfitsmayIncrease:Asaresultoflowercostsbusinessprofitsmayincrease,leadingtoanincreaseinCPTrevenues.

OutlinePossibleRestric)onsontheGrowthofBusinessesintheIrishEconomyatPresent

1) LimitedAvailabilityofCredit:Thebankingcrisishasresultedinalackofcredit,whichisamajorobstacletotheexpansionofbusiness.

2) Reduc)oninDomes)cDemand:Thecon:nuingrecessionhasresultedinamajordropinspendingresul:nginadropindomes:cdemandandlessopportuni:esforbusiness.

3) Restric)veWageAgreements:Theexistenceoftheminimumwage;theexistenceofJLCagreementslimitstheabilityoffirmstohirelabourwhichrestrictstheabilityoffirmtoexpand/grow.

4) Legisla)veRequirements/Framework:Permissionmayhavetobeobtainedfromthelocalauthority;statebodyetc.Forexampleifapersonwantstoextendarestaurantthencertainrequirementsmustbefulfilled.

5) Merger/TakeoverLegisla)on:Somebusinesseswishingtoexpandmayfaceaninves:ga:onunderEU(Irish)mergerandtakeoverlegisla:on.TheproposedtakeoverofAerLingusbyRyanairwasprohibitedunderEUlaws.

6) HighCostsofProduc)on:Businessesfinditdifficulttoexpandduetohighopera:ngcostse.g.rates;u:litycosts;insurancecosts;costsof



rawmaterials;andhighinterestratesmakesborrowingmoreexpensive.

SocialCosts

ExamplesofSocialCosts

1) Pollu)onofAirorWater:Whenbusinessesdisposeofwasteproductsfromtheproduc:onprocessinalakebesideitkillingwildlife.

2) DisfigurementoftheLandscape:Theconstruc:onofroadsconfiguresthelandscape

3) PossiblelossofCulturalHeritage:Theconstruc:onoftheM3throughthehillofTara

4) TrafficConges)on:Thiscausesstress,furtherairpollu:onandnoisepollu:on

5) Reduc)oninPublicAmeni)es:Communi:eshavelesspublicspaceslikeparks,playgroundsetc.

6) GlobalWarming:Increasedcarbonemissionsaffectsglobalweatherpacerns

OilPricesrosesteadilylastyear.Statetwoeconomicreasonsforthisdevelopment.Giveonesocialcostandonesocialbenefitoftherising

prices.

Reasons

1) GreaterDemandforOil:NewlyindustrialisedcountriessuchasChina,India(BRIC).

2) Affluence/EconomicGrowth:withhigherdisposableincomes/greaterpurchasingpower,asaresultofeconomicgrowththereisagreaterdemandforbiggervehicles,moreairlinetraveldrivingupoilprices.

3) ReservesofOilDeclining/HighCostofExtrac)on:Oilisanon-renewableresource.

4) GreenTaxes/ExciseDu)es:Inmanycountriesapercentageofthepriceisaformoftaxa:on.

SocialCosts:arethecostthatsocietyhastopayfortheexistenceofapar:culargoodorservice



5) LackofProduc)oninMiddleEast;e.g.Iraqconflict,poli:caluncertainty.

6) Specula)on:investorsarespecula:ngonfuturepricesofoilinworldmarkets.

SocialCosts

1) EnvironmentalDamage:Oilexplora:onincreasesasreservesrunlow(Irishcoastline)/destroyingrainforestsinordertogrowcropsforbiofuels.

2) LossofExciseDuty:Ifpeoplecutbackonuseofoil,governmentlosestaxrevenue.

3) IncreasingInfla)on:Therisingpriceofoilhasaddedtoinfla:onarypressuresinsomeeconomiesandaconsequentfallineconomicgrowth.

4) RisingWorldFoodPrices:Ascountriesswitchproduc:ontocropsforbiofuels,foodprocessrise.

5) ShortageofFood:par:cularlyindevelopingna:ons.

SocialBenefits

1) Environment:theremaybeareduc:oninpollu:onaspeoplecutbackonusethushelpingenvironment/greatereconomyintheuseofoil.

2) PublicTransport:Ifoilcostsriseconsumersmaybemorewillingtousepublictransport.

3) LessTrafficConges)on:Consumerscutbackonuseofcars.

4) Incen)vetoSourceAlterna)veSourcesofEnergy:Asoilbecomesexpensiveothersourcesofenergymaybecomeamoreviablesolu:on.



EconomicDevelopment

SocialCostsofEconomicDevelopment

1) Pollu)onofAirorWater:Whenbusinessesdisposeofwasteproductsfromtheproduc:onprocessinalakebesideitkillingwildlife.

2) DisfigurementoftheLandscape:Theconstruc:onofroadsconfiguresthelandscape

3) PossiblelossofCulturalHeritage:Theconstruc:onoftheM3throughthehillofTara

4) TrafficConges)on:Thiscausesstress,furtherairpollu:onandnoisepollu:on

5) Reduc)oninPublicAmeni)es:Communi:eshavelesspublicspaceslikeparks,playgroundsetc.

6) GlobalWarming:Increasedcarbonemissionsaffectsglobalweatherpacerns

WhySmallfirmsSucceedinSomeMarkets

1) PersonalService:Smallfirmsprovidepersonalacen:onintheprovisionofcertaingoodsandservicese.g.hairdresser,plumberetc.

2) SizeofMarketdoesn’tJus)fyaLargeSupplier:Therestrictedsizeofthemarketmaynotfacilitatetheopera:onoflargescalebusinesse.g.asmallshopinaruralareamaybeviablewhilealargesupermarketmaynot.

3)GovernmentAssistanceforSmallFirms:Thegovernmentmayprovideaidintheformofgrantsorsubsidiesforlabour.

4) ConsumerLoyalty:Smallfirmsmayhavebuiltupareputa:onovertheyearsintheprovisionofgoodsandservicestoitscustomerswhomayrespondbybeingloyaltothatfirm.

5) ViableCommunity:Ci:zensinsmallcommuni:esmaysupportlocalbusinesssothatcon:nuityofsupplyisensurede.g.acommunitymaysupportitslocalshopsothatitcon:nuesinexistence.

EconomicDevelopment:AnincreaseinGNPperheadofpopula:on,whichisaccompaniedbyafundamentalchangeinthestructureofsociety.



6)NicheorTradi)onalMarkets:Thetypeofproductorservicebeingsuppliedmightmakeitmoresuitableforasmallfirm.Examplesinclude:weddingplanners;handmade/cralproducts;perishableproductsetc.Asmallfirmmayfinditeasiertolocateclosetothemarketwhereitmightbedifficultforalargerfirmtodosoe.g.roadsidesellersoflocalproducecanbeflexibleinchoosingtheirloca:on.

7)NatureofProduct:Heavygoodswhicharecostlytotransportmaybemanufacturedlocallyonasmallscaletosupplylocalmarketse.g.concreteblocks

WhysomeMarketsareDominatedbyLargeFirms

1) ExistenceofEconomiesofScale:Largerfirmbenefitfromtheadvantagesoflargescaleproduc:onwherebyunitcostfallsasafirmexpandsinsize.Thenatureofsmallfirmsmakesitdifficulttoachievesucheconomiesofscale.

2) ExistenceofBarrierstoEntry:Makesitdifficultfornewfirmsenteringthemarkete.g.Mobilephonesindustry;bankingsector.

3) Adver)sing:Thecostofusingna:onalmediae.g.TV,newspapers,cinemaetc.isexpensiveandthiscostisprohibi:veforsmallfirmse.g.localsupermarkets.

4) ProductDifferen)a)on:InvestmentinR&Dtosuchanextentthatsmallfirmswouldnothavetheresourcestocompete.

5) BrandProlifera)on:Largefirmshavetheresourcestoinvestinestablishingmanybrandsandsmallfirmswouldnotbeabletocompeteonsuchabasis.



OutlinetheBenefitsandChallengesforIrishSMEsOpera)nginForeignMarkets.

TheBenefitsforIrishSMEsOpera)nginForeignMarkets

1) AccesstoLargerMarketstoIncreaseSalesandProfits:AsIrelandisaverysmallmarket,enteringforeignmarketsgivesIrishSMEsaccesstomorecustomersandmoreopportunitytoexpand.IfIrishSMEscansellmoregoodsabroadthiswillboosttheirrevenueandconsequentlytheirprofits.

2) EconomiesofScale:Iftheyaresuccessfulinincreasingsalesabroad,theywillbeabletoincreaseproduc:onandgaintheadvantagesoflargescaleproduc:onandthebenefitofeconomiesofscale.

3) DiversifyingRisk:RatherthanbeingoverlydependentonthehomemarketIrishSMEshavetheopportunitytohavearangeofcustomersindifferentmarketsandwouldsufferlessshoulddemandinthehomemarketfall.

4) EasiertoAccessFinance:Largerfirmsareabletoraisefinanceforfutureexpansionmoreeasilyandfinditeasiertoaccesscredit.

5)GovernmentSupportAvailable:TheIrishgovernmentmayoffergrantsorsubsidiesandassistanceinenteringtheexportmarketthroughthevariousstateagenciese.g.EnterpriseIreland

TheChallengesforIrishSMEsOpera)nginForeignMarkets.

1) TransportCosts:Theseincreasethepricesoftheexports.AsIrelandisanislandna:onthesecostscanbesignificantandcanmakeourgoodsmoreexpensive.

2) LabourCosts:LabourcostsinIrelandtendtobehighwhichwillincreasecostsofproduc:onandmakeitdifficulttocompetewithgoodsproducedinothercountries.

3) ExchangeRateRisksinTradingOutsideEurozoneCountries:IftheEurorisesinvaluerela:vetothetradingpartners,thenIrishexportsbecomemoreexpensiveandthispresentsachallengewhenIrishfirmsaretryingtocompeteabroad.

4) LanguageSkills:AlackoflanguageskillshasalwaysbeenachallengeforIrishbusinessbutposesmoreofachallengeintheemergingmarketsinAsia.

5) BureaucracyandRegulatoryHurdlesinOtherCountries:Theseregulatoryhurdles,par:cularlyoutsidetheEU,hinderthepossibility



forIrishSMEstoexpand.ItischallengingforIrishSMEstobreakintonewmarketse.g.China.

6) LevelofCostsifcomingfromaSmallMarket:IrishSMEsdon’thavethebenefitsofeconomiesofscalecomparedtolargeMNCsandthismakesitdifficultforthemtoacractbusiness,basedonprice.

7) Compe))veness:Iftheinfla:onrateinIrelandishigherthanthatofourcompe:tors,thenthismakesIrishgoodslessacrac:veabroad. Othercostse.g.insurancecosts,u:li:essuchaselectricity,gas,broadbandetc.aregenerallyhigherinIrelandthaninotherEuropeancountries–increasecostsofproduc:onandwillaffectthecompe::venessofIrishfirmsabroad.

8) AccessingCredit:IfIrishfirmscan’tgetaccesstocreditfrombankstofundexpansionitwillmakeitdifficultforthemtoenterinterna:onalmarkets.

9) CapacityoftheFirm:IrishSMEsmaynothavethecapacitytomeetdemandfortheirproductsabroadiftheysuccessfullysecurecontracts.

Discussthreeeconomicfactorswhichinfluenceafirm’sdecisiononwheretolocateitsopera)onswithinIreland.

1) ClosenesstoSimilarFirms:ManyIT/Techcompanies(Google,LinkedIn,Facebook)havenowlocatedwithinthesameareainDublin(knownasthe"Siliconvalley"ofDublin).Theessen:alsupportservicesareavailablecloseby.

2) AvailabilityofaSkilledWorkforce:Firmsneedaworkforcewithdiverselanguageskills/engineeringskills/ITSpecialistssothattheycancommenceopera:onsanddosowithminimumtrainingcosts.

3) ProximitytoMarketandRawMaterials:Afirmwhichreliesonasteadyflowofconsumersmustlocateclosetothemarketi.e.abou:que.Afirmwhichreliesontheusageoflargeamountofrawmaterialsmustlocateclosetotheavailabilityofthesee.g.apowergenera:ngsta:on.

4)WellDevelopedInfrastructure:Havingawelldevelopedinfrastructureiscrucialwhenfirmsaredecidingwheretolocate.Thisincludesroad,railandairtransportnetworketc.Theavailabilityofhighspeedbroadbandisalsocri:calinthisregard.

5)GovernmentIncen)ves:AvailabilityofAdvanceFactoriestogetherwithacrac:vegrantsareanotherconsidera:ontotakeintoaccountwhendecidingwheretolocate.TheIDAandEnterpriseIrelandprovidesupports.



6) CommercialPropertyPrices:Withthedownturnintheeconomyandthepropertycrash,commercialpropertypricestogetherwithcommercialrentshavesignificantlyreduced.ThishasmadeIrelandamoreacrac:veplacetolocateindustry.GooglehaspurchasedcommercialpropertyrecentlyinBarrowStreet,Dublin.

7) SocialInfrastructure:Firmswillconsidertheavailabilityofschools,hospitals,parksetcsothattheirworkforcecanhaveagoodlifestyle.

8) PlanningLaws:Irishplanninglawsareflexibleenoughtofacilitatelargemul:na:onalswhowishtosetuphere.Suchlawsfacilitatedtheconstruc:onoftheSwedishIkeaoutletclosetoDublin,whichledtothelargestretailoutletinthehistoryofthestate,beingbuilt.


6. Costs of Production - The Business Guys

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