Editing Economies of scale (section)

==Economies of scale and returns to scale==

Economies of scale is related to and can easily be confused with the theoretical economic notion of returns to scale.  Where economies of scale refer to a firm's costs, returns to scale describe the relationship between inputs and outputs in a long-run (all inputs variable) production function. A production function has ''constant'' returns to scale if increasing all inputs by some proportion results in output increasing by that same proportion. Returns are ''decreasing'' if, say, doubling inputs results in less than double the output, and ''increasing'' if more than double the output.  If a mathematical function is used to represent the production function, and if that production function is [[homogeneous function|homogeneous]], returns to scale are represented by the degree of homogeneity of the function.  Homogeneous production functions with constant returns to scale are first degree homogeneous, increasing returns to scale are represented by degrees of homogeneity greater than one, and decreasing returns to scale by degrees of homogeneity less than one.

If the firm is a perfect competitor in all input markets, and thus the per-unit prices of all its inputs are unaffected by how much of the inputs the firm purchases, then it can be shown that at a particular level of output, the firm has economies of scale if and only if it has increasing returns to scale, has diseconomies of scale if and only if it has decreasing returns to scale, and has neither economies nor diseconomies of scale if it has constant returns to scale.<ref>{{cite journal |last1=Gelles |first1=Gregory M. |last2=Mitchell |first2=Douglas W. |title=Returns to Scale and Economies of Scale: Further Observations |journal=Journal of Economic Education |volume=27 |date=1996 |issue=3 |pages=259–261 |jstor=1183297 |doi=10.1080/00220485.1996.10844915}}</ref><ref>{{cite book |last=Frisch |first=R. |author-link=Ragnar Frisch |title=Theory of Production |url=https://archive.org/details/theoryofproducti0000fris |url-access=registration |location=Dordrecht |publisher=D. Reidel |date=1965 }}</ref><ref>{{cite book |last=Ferguson |first=C. E. |title=The Neoclassical Theory of Production & Distribution |location=London |publisher=Cambridge University Press |date=1969 |isbn=978-0-521-07453-7 }}</ref>  In this case, with [[perfect competition]] in the output market the long-run equilibrium will involve all firms operating at the minimum point of their long-run average cost curves (i.e., at the borderline between economies and diseconomies of scale).

If, however, the firm is not a perfect competitor in the input markets, then the above conclusions are modified.  For example, if there are increasing returns to scale in some range of output levels, but the firm is so big in one or more input markets that increasing its purchases of an input drives up the input's per-unit cost, then the firm could have diseconomies of scale in that range of output levels.  Conversely, if the firm is able to get bulk discounts of an input, then it could have economies of scale in some range of output levels even if it has decreasing returns in production in that output range.

In essence, [[returns to scale]] refer to the variation in the relationship between [[Factors of production|inputs]] and [[Output (economics)|output]]. This relationship is therefore expressed in "physical" terms. But when talking about economies of scale, the relation taken into consideration is that between the average production cost and the dimension of scale. Economies of scale therefore are affected by variations in input prices. If input prices remain the same as their quantities purchased by the firm increase, the notions of increasing returns to scale and economies of scale can be considered equivalent. However, if input prices vary in relation to their quantities purchased by the company, it is necessary to distinguish between returns to scale and economies of scale. The concept of economies of scale is more general than that of returns to scale since it includes the possibility of changes in the price of inputs when the quantity purchased of inputs varies with changes in the scale of production.{{sfnmp|Morroni|1992|1p=142|Morroni|2006|2pp=164–165}}

The literature assumed that due to the competitive nature of [[reverse auction]]s, and in order to compensate for lower prices and lower margins, suppliers seek higher volumes to maintain or increase the total revenue. Buyers, in turn, benefit from the lower transaction costs and economies of scale that result from larger volumes. In part as a result, numerous studies have indicated that the procurement volume must be sufficiently high to provide sufficient profits to attract enough suppliers, and provide buyers with enough savings to cover their additional costs.<ref name="ShalevAsbjornsen2010">{{cite journal |last1=Shalev |first1=Moshe Eitan |last2=Asbjornsen |first2=Stee |title=Electronic Reverse Auctions and the Public Sector – Factors of Success |journal=Journal of Public Procurement |volume=10 |issue=3 |pages=428–452 |date=2010 |ssrn=1727409 }}</ref>

However, Shalev and Asbjornse found, in their research based on 139 reverse auctions conducted in the [[public sector]] by public sector buyers, that the higher auction volume, or economies of scale, did not lead to better success of the auction. They found that auction volume did not correlate with competition, nor with the number of bidders, suggesting that auction volume does not promote additional competition. They noted, however, that their data included a wide range of products, and the degree of competition in each market varied significantly, and offer that further research on this issue should be conducted to determine whether these findings remain the same when purchasing the same product for both small and high volumes. Keeping competitive factors constant, increasing auction volume may further increase competition.<ref name="ShalevAsbjornsen2010" />