Question

Suppose that just by doubling the amount of output that it produces each year, a firm's per-unit production costs fall by 30 percent. This is an example of: a. Economies of scale. b. Improved resource allocation. c. Technological advance. d. The demand factor.

Short answer

The correct answer is (a) Economies of scale.

Step-by-step solution

Understanding the Terms

Read the question carefully and understand the terms mentioned in the options. - 'Economies of scale' refers to the cost advantage that arises when there is a higher level of production, leading to reduced per-unit costs. - 'Improved resource allocation' involves better organizing resources to make production more efficient without necessarily increasing output. - 'Technological advance' means improvements in technology that make production more efficient. - 'The demand factor' relates to the changes in demand affecting production, not cost savings due to increased production.

Identifying the Right Concept

The scenario describes that the per-unit cost falls due to doubling the output. This suggests the firm is benefiting from producing a larger number of units that allows them to distribute the fixed costs over more units, reducing the per-unit production cost. This is characteristic of 'economies of scale'.

Matching Options with Scenario

After identifying 'economies of scale' as the relevant concept, compare this with the given options: - Option a, 'Economies of scale,' perfectly matches the description in the scenario, as it describes costs reducing due to increased production. - Option b, 'Improved resource allocation,' while beneficial, does not directly describe cost reduction from increased production. - Option c, 'Technological advance,' involves technology improvements, not larger production output. - Option d, 'The demand factor,' is unrelated to production costs. Therefore, option a is the correct answer.

Key concepts

Per-Unit Production Costs

Per-unit production cost is an important financial metric for businesses. It represents the cost incurred by a firm to produce one unit of a good or service. Understanding how to reduce this cost is crucial for enhancing profitability.

A major factor influencing per-unit production cost is the volume of production. When a firm increases its output, it can often distribute its fixed costs over a larger number of units. This way, the per-unit cost decreases, effectively boosting the company's efficiency.

Imagine a firm that produces 100 units of a product. If they double their production to 200 units, the expenses like rent and salaries (which do not change with output) are now spread across a greater number of units, reducing the cost associated with each item. Thus, a larger scale of production usually leads to lower per-unit costs, helping businesses become more competitive.

Output Increase

Increasing output can significantly impact a company's operational efficiency and overall costs. When firms expand their production, they often experience changes in several areas.

• Increased production allows for better utilization of machinery and resources.
• It may lead to higher bargaining power over suppliers, resulting in discounts on raw materials.
• A large-scale operation might also mean that companies can afford to invest in more efficient production technologies.

Another consideration is the potential for better product distribution. With increased output, companies might achieve greater market reach, enhancing their sales prospects. As production scales up, businesses often gain a competitive edge through lower prices or improved product quality, driven by cost efficiencies.

Cost Advantage

A cost advantage arises when a company is able to produce goods or deliver services at a lower cost than its competitors. This advantage is tightly linked to economies of scale, which describe the cost benefits that firms experience when they increase production.

Achieving a cost advantage can happen through several avenues:

• More efficient processes or technology that boost productivity.
• Bulk purchasing of materials leading to price reductions from suppliers.
• Spreading fixed costs over a larger number of units, significantly dropping the marginal cost.

Securing lower costs allows businesses to offer competitive pricing or enhance their profit margins. It also provides flexibility in pricing strategies, enabling firms to either reduce prices to capture market share or maintain prices and enjoy increased profitability.

Resource Allocation

Effective resource allocation is about utilizing all available resources such as time, manpower, and materials in the most productive way possible. It ensures that resources are distributed in areas where they have the maximum impact.

Allocating resources wisely helps in:

• Maximizing productivity and efficiency across production processes.
• Reducing waste and enhancing the overall sustainability of operations.
• Aligning resources to strategic goals, ensuring no area of the operation is under-resourced.

While resource allocation itself doesn't directly cause a drop in per-unit costs, it enhances the underlying structure, setting the stage for other efficiency gains. Well-planned allocation supports growth and is often a precursor to achieving the economies of scale that directly lower costs.