The size of a firm or farm significantly influences its output levels, profitability, and the efficiency of resources used in production. Generally, larger firms or farms are expected to enjoy greater economies of size. However, these economies depend on various factors, including the managerial and administrative expertise of the resource manager.
What Are Economies of Size?
Economies of size refer to the reduction in the average cost per unit of production as the size of the farm or firm increases. This concept is also used to describe the decline in total cost per unit of production observed in larger farms. These economies arise when a farmer can spread production over the same level of fixed expenses. Additionally, economies of size can occur when a farm secures volume discounts for inputs such as seeds or fertilizers.
For example, consider the cost of pollution monitoring around a swine production facility. If the farm is required to monitor groundwater for contamination, it must install a well and monitoring equipment, which are fixed costs. These fixed costs can serve a large number of pigs. As the number of pigs sold increases, the cost per pig for monitoring decreases, providing a cost advantage to larger operations.
It is important to distinguish economies of size from two related concepts: economies of scale and economies of scope.
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Economies of Size vs. Economies of Scale
Economies of scale measure the impact of increasing all inputs by the same proportion. If the cost per unit decreases, there are increasing economies of scale. If the cost per unit increases, there are diseconomies of scale. If the cost per unit remains unchanged, there are constant returns to scale.
According to Kay (1981), fixed costs such as management, supervision, information, and machinery can be spread over more units of output, leading to reductions in cost per unit and increasing returns to scale or size. Returns to scale are defined as the proportionate change in output when all inputs are increased in the same proportion.
In mathematical terms, economies of scale are equivalent to the inverse of the sum of all elasticities of total production cost with respect to all outputs. Economies of scale exist if the sum of the elasticities of production is greater than 1. Diseconomies of scale occur if the sum is less than 1. If the sum equals 1, neither economies nor diseconomies of scale exist.
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Economies of Size vs. Economies of Scope
Economies of scope involve reducing costs by spreading resources over more than one enterprise. This concept refers to the process of lowering the cost of resources and skills for an individual business by utilizing these resources across two or more enterprises.
For example, if resources are used in two enterprises instead of one, the cost per enterprise is halved. If spread over three enterprises, the cost per enterprise is reduced to one-third.
Both horizontal integration and vertical integration enable farms and businesses to achieve economies of scope. For instance, a combination of fishery and poultry represents a horizontally integrated enterprise.
If the cost of producing both poultry and fish in such a farm is lower than producing them separately, the farm enjoys economies of scope. Conversely, if the cost is higher, the farm experiences diseconomies of scope.
Economies of scope can arise from shared resources, such as using the same workers for feeding poultry and maintaining fish ponds or utilizing the same water source for multiple enterprises. In crop production, the cost of a combine harvester can be spread across several crops by simply changing the combine head, eliminating the need to purchase separate equipment for each crop.
Farmers can also apply agronomic skills to the production of multiple crops. For example, a farmer who is also a seed dealer can use their knowledge of seed selection both in farming and sales. Similarly, farmers who sell crop insurance can leverage their expertise across multiple enterprises.
While economies of scope involve spreading costs over multiple products or enterprises, economies of size focus on spreading fixed costs over a large number of units of the same product or enterprise. However, these two concepts are not mutually exclusive. Economies of scope can be achieved by spreading costs across multiple enterprises, while economies of size can be realized by increasing the scale of each enterprise.
This article has explored the concept of economies of size and its related concepts: economies of scale and economies of scope. Economies of size describe the reduction in total cost per unit of production observed in larger farms, achieved by spreading fixed costs over a greater volume of output.
Economies of size differ from economies of scope, which involve spreading costs across multiple products or enterprises, and economies of scale, which measure the impact of proportionally increasing all inputs. Understanding these concepts is crucial for optimizing production efficiency and profitability in agribusiness.
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