People in business and research scholars are familiar with the term “economies of scale.” But in the present era of chaotic competition, It is now believed that this term is largely being replaced by the term, “economies of scope.” I wish to know all the possible and detailed features of the term “economies of scope” and how it actually works.
Economies refers to the benefits we reep in terms of cost saving.Economies of scale is when we get these benefits (like financial, managerial etc) by changing the scale of production of a product (from small scale to large scale) whereas in economies of scope we talk of economies/benefits we derive when producing more than one product
To know whether we are getting certain economies or not , one can calculate the average cost... Lower the average cost, more are the economies.
Anu you are talking about economies of scale. I was curious to know about 'scope'.
@debi
the major and only difference I am aware of between scope and scale is that we take one product in case of scale whereas we take 2 or more products in case of scope
Economies of scope exist if average total cost of production falls as a result of introducing a number of different goods produced by a firm or due to introduction of newer varieties of goods by the same firm. Consider a Kolkata street food seller example.
For example, a pani puri seller can produce both pani puri and aloo chat at a lower average cost than what it would cost (average) two separate pani puri sellers to produce the same goods. This is because both pani puri and aloo chat share the use of almost the same ingredients and primary inputs, food storage and preparation facilities for production.
Erik Hovenkamp explains it correctly. In essence, economies of scope is achieved when, as the organization (or production system or facility) engages in more different activities, the sum of all the activities becomes cheaper than they would be separately on a per-unit basis. Vertical integration is sometimes justified by an "economies of scope" argument.
In the economics literature the term economies of scope is often used in the context to the multi-product firm. According to Panzar and Willig (1981, p. 268) "[t]here are economies of scope where it is less costly to combine two or more product lines in one firm than to produce them separately." Put differently, it is the synergistic effect of joint production.
References:
Panzar, J. C., & Willig, R. D. (1981). Economies of Scope. The American Economic Review, 71(2), 268–272.
Erik Hovenkamp did explain correctly (and elegantly) what are economies of scope. May expand a little this discussion. No matter what is the choice of competitive strategy, costs are always important, you need cost competitiveness. This means you must learn how to best exploit sources of cost efficiency. In the long run, when you plan how to operate your business (in the short run), you face opportunities to strenghten your cost efficiency along these lines: (1) economies of scale, (2) economies of scope and (3) economies of learning. Of course, there are limits to every lane you take and these limits change over time. What was best yesterday may not be good today.
There also some obstacles to implementing cost analysis so as to allow optimal choices of scale, scope and learning. One is that most cost systems, in practice, were created to serve the needs of financial accounting, not the requirements of management. ABC (Actitivy Based Costing) is better than any traditional cost system, but so far it has been mostly confined to short run considerations - that is to say, how costs are incurred within a particular "configuration" of scale, scope and learning.
A long road ahead still awaits for more interest and creative power, therefore. Thanks you all for you valuable comments, that raised my own interest in this discussion.
Another definitive exposition is in Contestable Markets and the Theory of Industry Structure by Baumol, Panzar, and Willig, HBJ, 1982. They provide verbal, graphical, and mathematical definitions of EOS and Economies of Scope.
Baumol is indeed the first stop. Additionally, Tirloe's chapter on the theory of firms gives some examples (The Theory of Industrial Organization, MIT Press 1988).
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