Minimum Efficient Scale - Explained
What is Minimum Efficient Scale?
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Table of ContentsWhat is Minimum Efficient Scale?How to Determine the Minimum Efficient ScaleChasing Changing VariablesRelationship to Market StructureAcademic Research on Minimum Efficient Scale
What is Minimum Efficient Scale?
Minimum efficient scale refers to the lowest point on the long-run average cost curve where the firm can achieve economies of scale.
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How to Determine the Minimum Efficient Scale
When it comes to classical economies, MES is the lowest production point where long-run average costs (LRATC) is minimized. LRATC represents the outputs average cost per unit over the long run, and this is where all inputs are variable.
A minimum efficient scale corresponds typically to the lowest point on the long-run average cost curve enabling a business to achieve productive efficiency. It is critical for those firms that produce goods to find an optimal balance between production volume, consumer demand, and cost of manufacturing and delivering those goods.
Note that it is possible for a range of production values to express a minimum efficient scale. However, the degree of demand for the product is the one that determines the number of competitors that can adequately function in the market.
Chasing Changing Variables
There are chances of a company failing if it is not able to maintain a balanced MES. A healthy minimum efficient scale has several factors that keep on shifting. So, to reflect these changes, there is a need for recalculating MES frequently. Also, there is a need for a business to adjust its production to continue hitting the set mark. It is crucial for a business to keep up to date with the changes when assessing the minimum efficient scale. The changes may be external variables such as storage, labor, and shipping expenses that are likely to affect production. Other modifications may include the cost of capital, customer base, competition, consumer demand and base, the size of the market, employee turnover, wage increases, and government regulations.
Relationship to Market Structure
Firms use minimum efficient scale concepts to determine the possible market structure of the overall market. For example, if the MES is small relative to the total demand for the good (size of the market), there will be a large number of companies. Due to a large number of competitors, the companies in this market may perform in a perfectly competitive manner. On the other hand, when MES is low, relative to the whole industry's size, then a large number of firms can function efficiently. A good example is retail businesses, such as restaurants and corner shops. However, there are instances where MES can only be achieved at high levels of output relative to the overall industry. In such cases, there will be a small number of firms in that particular industry. A good example is the natural monopolies like gas, water, and electricity supply.