Minimum efficient scale
In industrial organization, the minimum efficient scale (MES) or efficient scale of production is the lowest point where the plant (or firm) can produce such that its long run average costs are minimized.
Relationship to average cost and marginal cost
The minimum efficient scale can be computed by equating average cost (AC) with marginal cost (MC). The rationale behind this is that if a firm were to produce a small number of units, its average cost per unit would be high because the bulk of the costs would come from fixed costs. But if the firm produces more units, the average cost incurred per unit will be lower as the fixed costs are spread over a larger number of units; the marginal cost is below the average cost, pulling the latter down. The efficient scale of production is then reached when the average cost is at its minimum and therefore the same as the marginal cost.
Relationship to market structure
The concept of minimum efficient scale is useful in determining the likely market structure of a market. For instance, if the minimum efficient scale is small relative to the overall size of the market (demand for the good), there will be a large number of firms. The firms in this market will be likely to behave in a perfectly competitive manner due to the large number of competitors.[1]
References
- Carlton D. and Perloff M.: "Modern Industrial Organization" Fourth Edition, 2005