11/29/2023 0 Comments Fixed costs in business![]() ![]() In much of the U.S., utilities are still a privately provided service and state or local government allows the monopoly to exist but regulates prices and practices to put a damper on aggressive behavior. As a result, many utilities experience economies of scale large enough to constitute a natural monopoly, as many Americans have just one electricity, water or gas provider in their area. Once established, though, the cost of the actual natural resources to create the utility is comparably low. Providing a utility requires the development of massive infrastructure - building out the plant, laying the distribution network and reaching every customer - making fixed costs for these projects incredibly high. ![]() Regulated utilities are the textbook example of economies of scale, Handy says. ![]() Thus, industries that operate with high fixed costs and enjoy low marginal costs benefit the most from economies of scale, creating large barriers to entry for potential competitors, insulating themselves from competition and padding their margins. These types of industries cannot fully benefit from economies of scale, because even at substantial size, high variable costs prevent these firms from reducing their average total cost per unit, even as output increases, Handy says. While all firms benefit from spreading fixed costs over more units and will experience economies of scale at some point in their life cycle, many operate in industries where marginal cost cannot be substantially reduced as output increases, especially service-dominated industries such as hotels, restaurants or tourist attractions. But as the firm grows larger, various coordination issues arise, such as managing different divisions or communicating between teams, which can cause a large firm to be less efficient.Īs a result, a firm’s marginal cost - or the combined fixed and variable cost of producing one additional unit - can sometimes increase as the firm grows larger, even as their output increases. In the early stages of a firm’s growth, the average total cost to produce a good or service decreases because the firm spreads their initial fixed cost over more units of output, Handy explains. In contrast, variable costs relate directly to the actual good or service produced, such as the raw materials or labor, and increase proportionally with each additional unit produced. All firms incur fixed costs just to begin operations, such as buying machinery, building out a factory or designing the product, Handy says. “For any firm, their total cost - or expenses - can be divided into two categories: fixed and variable,” says Chris Handy, a teaching assistant professor of economics at the University of North Carolina–Chapel Hill. When employed to a great degree, economies of scale create cost advantages for large producers and insulate them from new competition - a lucrative proposition for a firm (and its shareholders). Simply put, economies of scale occur when a firm’s average total cost to produce a good or service decreases as they increase their quantity of output. ![]() Investing in software companies and data centers. Business & Finance Click to expand menu. ![]()
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