Economies and diseconomies of scale in managerial economics

applied managerial economics
Type: Discussion Board

Unit: Efficiency & Cost of Production

Due Date: Sun, 6/5/16

Grading Type: Numeric

Points Possible: 75

Assignment Objectives-

Demonstrate how metrics such as valuation, economic profit, and related terms are measured and evaluated.

Explain the significance and implications of various economic theories pertaining to profit, consumer choice, demand and supply, forecasting and optimization.

Assignment Details

Within the Discussion Board area, write 600–800 words that respond to the following questions with your thoughts, ideas, and comments. This will be the foundation for future discussions by your classmates. Be substantive and clear, and use examples to reinforce your ideas:

Additional Information: Because the decision about relocating manufacturing operations to the United States is so important, the board of directors at Auto Edge continues to systematically discuss every aspect of the situation.

The following week, CEO Lester Scholl meets you for coffee to discuss next week's board meeting.

"I'm hearing good things about you," he says. "Ingrid and George tell me you've been very responsive and helpful."

"That's good to hear," you say. "I've enjoyed working with them."

"We're both busy, so I'll get right to the point," he says. "One of the main objectives of any business is to be efficient. Without efficiency, the company is essentially losing money. Am I right?"

"Absolutely," you say.

"What must Auto Edge do," he says, "to obtain economies of scale with production? How do we know that it has achieved economies of scale? Conversely, how do we know if it is achieving diseconomies of scale?"

"That's a good question," you say. "I can understand why you ask."

But before you can respond, Lester's cell phone rings. After a minute, he ends the call and stands.

"I have to get back to the office to handle an emergency," he says. "Would you send me an e-mail with an answer to my questions, please?"

"No problem," you say. "I'll get it to you before I leave work this afternoon."

"I appreciate it," he says. "Thanks."

Scenario

Auto Edge is a leading national automotive supply company located in Detroit, Michigan. Founded by Jonathan McAlister in 1976, the company specializes in engines and transmission parts and has been supplying products to the three largest U.S.-based automakers for over 30 years. AutoEdge’s name is known by customers and leaders in the automotive industry for quality, dependability, and reliable products. In fact, despite the extra cost that is added to the automobiles, consumers appreciate the AutoEdge brand name and often make purchases because of it.

In 2005, AutoEdge’s board of directors decided that the company needed to make some drastic changes because of the high cost of labor, rigid American regulations, and increased competition from other engine and transmission part suppliers. Their solution was to gradually close all manufacturing operations in Detroit and begin outsourcing to a well-known factory in South Korea. The board reasoned that this change would allow the company to compete with the growing industry, meet the automotive manufacturing demands, and increase company profits. Some board members were skeptical about the move, however, because Auto Edge had built a reputation for high-quality, detailed craftsmanship, and they feared that transitioning the manufacturing operations overseas would cause quality to diminish.

For the next 5 years, this strategy proved successful. The company showed signs of financial growth and company profit.

However, in 2010, the company was found guilty of supplying products that failed quality tests. As a result, millions of automobiles had to be recalled. The recall was highly publicized, and the issue of poor quality products impacted negatively on American automotive companies. Auto Edge’s $51 per-share stock has fallen to $4 per share, and brand acceptance has come under scrutiny among even its most loyal customers. Although some economists blame these negative effects on the products, others believe that it had to do with the termination of Auto Edge’s Chief Executive Officer, Fred McFadden.

Lester Scholl, Chairman of the Board of Directors, has called an emergency meeting to discuss AutoEdge’s short-term and long-term strategies. Among other things, they need to discuss the possibility of continuing production overseas or returning it to the United States. Lester and others on the board are well-known for being financially conservative and risk-averse. Because the American economy is experiencing high unemployment, low interest rates, low GDP, and low inflation, it might be sensible to make the change. To some extent, they believe that these macroeconomic factors can be used to their advantage. They realize the immediate challenges such as the brand damage, the growing competition, and the financial challenges the company is facing require immediate action. A new strategy must be formulated quickly to save the company from bankruptcy.

You have been hired by AutoEdge’s board of directors as a research analyst. Primarily, your job is to list and describe some of the legal, cultural, financial, and economic factors that AutoEdge needs to consider when deciding to either stay in South Korea or return to the United States. Because Fred McFadden was recently terminated, you will work directly with the board until a new CEO is named.

Compare and contrast how production analysis is carried out and be able to evaluate production situations using economy of scale, elasticity and other analytic tools.

Points Earned: 0

Deliverable Length: Primary Task: 600–800 words

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Introduction

Auto Edge will requires to carry out appropriate production situation analysis to see whether it will be able to reduce cost production before undertaking a final decision with respect to relocating the production facility in USA. Whether the company will be achieve to lower cost or not will be dependent upon whether it will achieve ‘economies of scale’ or face ‘diseconomies of scale’ in production. If Auto Edge achieves ‘economies of scale’ in production it will be able to reduce per unit cost, and if Auto Edge faces ‘diseconomies of scale’ in production it will not be able to reduce per unit cost.

Economies of scale in production and minimization of per unit cost of output

Economies of Scale and Diseconomies of Scale are two important microeconomic concepts that are widely used in the production analysis (Mankiw, 2014). The two concepts main depict the underlying relationship in between level of production and average cost per unit of production (Mind Tools, 2016). More specifically, how per unit cost of product changes with the changes of level of production can be understood from studying of ‘Economies of Scale’ and ‘Diseconomies of Scale’.

Economies of scale refers to a situation when the average cost of the products decreases with the increase of total output (Mankiw, 2014). On the other hand, Diseconomies of scale refers to a situation when the average cost of the products increases with the increase of total output (Mankiw, 2014).

In the long term, a company enjoys economies of scale up to a certain level of production till optimal level of production is achieved at which production is maximized and per unit cost is minimized (Figure 1) (Stankich, 2016). After optimal level of production, the company faces diseconomies of scale situation (Figure 1). Up to optimal level of production as with increase of production level per unit cost of output will be reduced, but after optimal production level per unit cost of output will be increased (Mankiw, 2014). Thus, Auto Edge will require to find out the optimal level of production at which per unit production cost is lowest.

Figure 1: Economies of Scale and Diseconomies of Scale in production

If Auto Edge decides to redirect the production facility to the USA, the increased cost of production will be a concern to the company. In that case, the company will require to achieve high efficiency in the production. For achieving cost control in production, the company will require to carry out production analysis. It will require to ensure ‘Economies of Scale’ in production. Diseconomies of Scale in production will result in higher per unit of production.

Economies of Scale is achieved that an organization has cost advantage in the production. Auto Edge can ensure cost advantage as well as economies of scale in its production through one or combination of the following ways.

· Setting up new machines that are more efficient and effective in production time and materials usage (Mind Tools, 2016).

· Finding out new production formula which results in less usage of raw materials and less wastage in production (Mind Tools, 2016).

· Using of raw materials which results in less wastage and less time in production (Mind Tools, 2016).

· Using of more efficient labor in production (Mind Tools, 2016).

Conclusion

To successfully running the production facility in USA, Auto Edge will require to achieve cost control as well as achieve economies of scale in its production. It will require to find out the optimal level of production where per unit cost of output of company will be lowest. The company can try to achieve economies of scale through setting up new machines, finding out new production formula, using effective raw materials, using more efficient labor in production etc.

Bibliography Mankiw, G. (2014). Principle of Economics. New York: Cengage Learning. Mind Tools. (2016). Retrieved June 07, 2016, from Achieving Economies of Scale: https://www.mindtools.com/pages/article/newSTR_63.htm Stankich, B. D. (2016). Chron. Retrieved June 07, 2016, from Economies of Scale vs. Diseconomies of Scale: http://smallbusiness.chron.com/economies-scale-vs-diseconomies-scale-78858.html