Chapter 2

Question 1

What are economies of scale

Answer 1

when the average cost declines as output increases.
If AC < MC

Question 2

What are diseconomies of scale

Answer 2

When the average cost is increasing, then the marginal cost must exceed the average cost, and we say that production exhibits diseconomies of scale.
If AC > MC

Question 3

What is the minimum efficient scale (MES)

Answer 3

The minimum output to achieve economies of scale

Question 4

What are economies of scope

Answer 4

Economies of scope exist if the firm achieves savings as it increases the variety of goods and services it produces. E.G. Ikea

Question 5

What are indivisibility

Answer 5

Indivisibility simply means that input cannot be scaled down below a certain minimum size, even when the level of output is very small.

Question 6

How to achieve economies of scale

Answer 6

• spreading of product specific fixed costs
• trade-offs among alternative technologies
• indivisibilities (inability to run equipment below a certain output)

Question 7

Economies of scale rules of thumb

Answer 7

1. Substantial product-specific economies of scale are likely when production is capital-intensive.
2. Minimal product-specific economies of scale are likely when production is materials or labor-intensive.

Question 8

sources of economies of scale and scope

Answer 8

1. Economics of density
2. Purchasing
3. Advertising
4. Research and development
5. Physical properties of production
6. Inventories

Question 9

Sources of diseconomies of scale

Answer 9

1. Labor costs and. Firm size
2. spreading specialized resources too thin
3. Bureaucracy

Question 10

What is the learning curve

Answer 10

Refers to advantages that flow from accumulating experience and know-how

Question 11

What is unrelated diversification

Answer 11

A firm that creates, for example, medical devices and popular music.
Two totally unrelated markets

Question 12

The learning curve vs economies of scale

Answer 12

Economies of scale refer to the ability to perform an activity at a low unit cost at a certain output.
Learning economies refer to the reductions in unit costs due to accumulating experience over time.

Question 13

Firm reasons for diversification

Answer 13

1. Benefit the owners by increasing efficiency
2. Diversification may reflect the preferences of the firm’s managers

Question 14

Efficiency-based reasons for diversification

Answer 14

1. To achieve economies of scope
2. To make use of an internal capital market

Question 15

What is the BCG Growth/Share Matrix: a growing market with a relatively high share

Answer 15

Rising star

Question 16

What is the BCG Growth/Share Matrix: a growing market with a relatively low share

Answer 16

Problem child

Question 17

What is the BCG Growth/Share Matrix: a declining market with a relatively high share

Answer 17

Cash cow

Question 18

What is the BCG Growth/Share Matrix: a declining market with a relatively low share

Answer 18

Dog

Question 19

What are problematic justifications for diversification

Answer 19

1. Diversifying shareholder’s portfolio
2. Identifying undervalued firms

Question 20

Reasons not to diversify

Answer 20

• Divisions will outperform others which takes away the incentive of managers of the money-losing divisions because they are not stand-alone businesses.
• Bureaucracy effects
• Diversifications impose uniform organization design while not being efficient for the business unit

Question 21

Managerial reasons for diversification

Answer 21

1. managers like running larger firms
2. managers pursue unrelated acquisitions in order to increase their compensation
3. Managers limit the risk of extremely poor overall profitability
4. Problems of corporate governance

Question 22

A firm is diversified when…

Answer 22

They produce for numerous markets.