Economies of Scope and the Learning Curve

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Economies of Scope and the Learning Curve

• Outline
• What are economies of scope?
• Measuring economies of scope
• Real world examples
• The learning curve
• Source of learning
• Cost and profit maximization
• The shut down rule

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Economies of Scope
If a single firm can jointly produce goods X
and Y more cheaply that any combination of firms
could produce them separately, then the
production of X and Y is characterized by
economies of scope
This is an extension of the concept of
economies of scale to the multi product case
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Economies of scope can be measured by as follows
Where C(Q1,Q2) is the cost of jointly producing
goods 1 and 2 in the respective quantities C(Q1)
is is the cost of producing good 1 alone, and
similarly for C(Q2).
Example Let C(Q1) 12 million C(Q2) 8
million and C(Q1,Q2) 17 million. Thus
Thus joint production of goods 1 and 2 would
result in a 15 percent reduction in total costs
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Economies of scope arise from complementarities
in the production or distribution of distinct
goods or services
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Real world examples

• Economies of scope between cable TV and high
  speed internet service.
• Production of timber and particle board.
• Corn and ethanol production
• Production of beef and hides.
• Power generation and distribution
• Joint cargo and passenger transportation in
  airlines reduces excess capacity.
• Global wholesale distribution of cheese, salad
  dressing, and cigarettes (example
  Phillip-Morris-Kraft).
• Computer aided design of (CAD) of aircraft
  components.

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The Learning Curve
The learning curve embodies the (inverse)
relationship between average production cost and
cumulative output.
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Over 1,000,000,000,000,000 sold
We should have this figured out by now
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Sources of learning

• The experience of the workforce tends to increase
  with cumulative outputthus workers are more
  familiar with the production process and have
  their movements/activities become routinized or a
  matter of habit.
• There are usually several ways to do a task, and
  it takes time and experimentation to find the
  best way.
• Quality control for inputs and outputs needs time
  to identify potential problem areas.
• Input suppliers have their owning learning process

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Figure 7.6a
Example Texas Instruments pushed calculator
prices from about 1,000 to around 10 in the
1970s.
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Average cost is a decreasing function of
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Figure 7.6b
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Learning is manifested by a downward shift of the
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Figure7.7 Costs and Profit-Maximization The
single product case
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Green-shaded area is economic profit
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Figure 7.8 Loss Minimization Means producing Some
Output
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Summary

• If the firm shuts down production, then losses
  will be equal to fixed cost, or
  Losses ????
• If the firm supplies Q units at the price P,
  then
• Losses ???P

Moral of the story So long as price (average
revenue) exceeds average variable cost, the loss
minimizing strategy will entail producing some
output.