Minimum efficient scale is the lowest point where the long-term average cost is at the minimum point. Prior to this point, the increase in production will be at a reduced average cost (economies of scale). And after that point, the average cost increases with increasing output (diseconomies of scale).
In short, it is a limit point to decide whether to increase output or not. After a minimum efficient scale, a company can’t increase production without incurring an increase in average costs.
How the minimum efficient scale works
Initially, the long-run average cost curve was downward sloping due to economies of scale. As far as operating in economies of scale output range, companies should increase production as unit cost is lower.
Decreasing average cost occurs due to several reasons, such as increasingly specialized workers and price discounts of buying large volumes of inputs.
After reaching the minimum point, the company will bear an increased average cost as it tries to raise output. Diseconomies of scale emerge because huge factories create many overlapping jobs. Also, when buying large quantities continuously, resources become scarce, raising the price. Increased input prices cause more expensive production costs
Why an minimum efficient scale is important
The minimum efficient scale concept is essential. It tells us the range of outputs where the business is achieving productive efficiency.
It is a turning point when deciding whether to increase production or not. When operating on economies of scale, companies must increase production as they bear lower unit costs, allowing them to charge the lower price.
Of course, the lower price makes companies competitive and achieve superior performance over their competitors. Lower prices are crucial, particularly if players base product price for their competitiveness, not on differentiation.
Effects on competition
Companies reduce average costs through a combination of optimal technology, capital, factory capacity, and labor.
In a perfectly competitive market, all companies operate at the minimum efficient scale. It is because, in the long run, the price equals the minimum average cost.
The concept of a minimum efficient scale does not only apply to large manufacturers, but also small manufactures. Small ones re likely able to also achieve efficiency scale, for example, from efficient managerial tasks in organizing work. Also, to do, it requires investment in specialized technology and equipment, which makes the process more efficient and reduces the average cost.
A high MES is an essential indicator of entry barriers. As it requires to produce larger quantities to achieve economies of scale, newcomers will find it challenging. They must invest heavily on a large scale to build production facilities. And not all companies are capable, either due to lack of capital or technical knowledge of the production process.