Question

1:Cost reductions increase profits. Describe 3 out of the 8 ways firms reduce costs and provide your own real examples.

2: Give your own examples of economies of scope and economies of scale.

Answer 1

PROFIT- profit is the margin between the revenue generated through the sale of a product and the cost price of the product.this implies that if the margin is large the profit is also greater and vice versa is also true.

reduction in cost leads to increase the profit margin.this can be understood by the following example.

• A ltd was producing a product and the cost was $10 per product and the revenue from sale was $15 .that means the margin between the revenue and cost if $5and thus profit was $5.
• now assume by updating technology the firm produced the same product at $8 and let the revenue from sale assumed to be constant at $15 that means the margin increased by $2 and new profit is $7.

REDUCTION IN COST-

1. EMPLOYING SKILLED AND EFFICIENT LABOR- suppose a firm employed some skilled laborer in the firm,the skilled labors would make less wastage of resources and will do work efficiently.therefore the ultimate cost of the product would decline and as a result the profit margin would increase.
2. INTRODUCING NEWER TECHNOLOGY-by introducing newer technology in long run the firm can produce better quality goods at a cheaper rate and overall the profit of the firm can be increased and market share can be increased and competition can be faced easily.
3. UTILIZATION OF EXCESS CAPACITY-when a firm utilizes the excess capacity then the per product cost declines and as a result the profit of the firm increases.
4. cheap and effective manner of advertisement
5. choosing best manner of financial resource to decrease the financial cost
6. efficient use of available resources
7. purchase and store the raw material in off season
8. bulk buying.

• ECONOMIES OF SCOPE- economy of scope is a concept which is concerned with the product usage and core diversifaction.this can be understood with a simple example stated below-   R ltd is an insurance company which provide life insurance in the market.it has a huge channel of marketing and labor employed.now if it wants to role out a new kind of policy say car insurance,accidental insurance,health insurance then it won't increase the cost of the industry or may incur minor additional cost because the all new policies can be sold by the existing labor and thus practically the total cost of the firm decreases.

• ECONOMIES OF SCALE- economy of scale is concerned with the level of production.when a firm is executing the production process at a larger level then it enjoys both the internal economics and external economics.it enjoys the benefit of lower average and thus total cost, easily adaption of newer technology,benefit of discount due to bulk level buying etc.