A2 Micro: Minimum Efficient Scale

The minimum efficient scale (MES) is the scale of production where the internal economies of scale have been fully exploited. The MES corresponds to the lowest point on the long run average cost curve and is also known as an output range over which a business achieves productive efficiency.

The MES is not a single output level – more likely we describe the minimum efficient scale as comprising a range of outputs where the firm achieves constant returns to scale and has reached the lowest feasible cost per unit.

The minimum efficient scale depends on the nature of costs of production in a specific industry.

In industries where the ratio of fixed to variable costs is high, there is plenty of scope for reducing unit cost by increasing the scale of output. This is likely to result in a concentrated market structure (e.g. an oligopoly, a duopoly or a monopoly) – indeed economies of scale may act as a barrier to entry because existing firms have achieved cost advantages and they then can force prices down in the event of new businesses coming in!

1. In contrast, there might be only limited opportunities for scale economies such that the MES turns out to be a small % of market demand. It is likely that the market will be competitive with many suppliers able to achieve the MES. An example might be a large number of hotels in a city centre or a cluster of restaurants in a town. Much depends on how we define the market!

2. With a natural monopoly, the long run average cost curve continues to fall over a huge range of output, suggesting that there may be room for perhaps one or two suppliers to fully exploit all of the available economies of scale when meeting market demand.

The market structure of an industry is affected by the extent of economies of scale available to individual suppliers and by the total size of market demand. In many industries, it is possible for smaller firms to make a profit because the cost disadvantages they face are relatively small. Or because product differentiation allows a business to charge a price premium to consumers which more than covers their higher costs.

A good example is the retail market for furniture. The industry has some major players in each of its different segments (e.g. flat-pack and designer furniture) including the Swedish giant IKEA. However, much of the market is taken by smaller-scale suppliers with consumers willing to pay higher prices for bespoke furniture owing to the low price elasticity of demand for high-quality, hand crafted furniture products. Small-scale manufacturers can therefore extract the consumer surplus that is present when demand is estimated to have a low elasticity of demand.