Sometimes firms produce more than one output. The outputs could be closely linked to one another, as in case of a poultry farm, which produces both chicken and eggs. The outputs could be physically unrelated. In some cases, the production of one output yields by-products that could be valuable to the firm.
Production with Two Outputs: Economies of Scope
The firm is likely to enjoy production or cost advantages when it produces two or more outputs. Such economies /savings that arise on account of a single firm producing two or more outputs are known as ‘Economies of Scope’.
Thus, if a firm’s joint output is greater than the output that could be achieved by two different firms when each produces a single product, then its production process enjoys ‘Economies of Scale’.
These advantages occur on account of the joint use of inputs, processes and economies of management, technology, marketing and so on. The best example is of automobile companies that produce more than one product.
Product Transformation Curve
The situation of joint production of two commodities can be depicted through a Product Transformation curve. Such a curve shows the various combinations of the two different outputs that can be produced with a fixed amount of inputs. In the figure below, we have shown that an automobile company which produces both cars and buses.
The curve PT shows the various combinations of cars and buses that can be produced using a given amount of labour, capital and other inputs. The curve has a negative slope because in order to get more of one product, it needs to give up the production of the other product.
The curve is concave in shape, explaining the economies of scope in production. The concave shape explains the advantages of joint sharing of resources, management, and expertise, which leads to cost advantages.
If the production transformation curve is a straight line, then joint production would give no advantage. In such a case, an individual company producing only cars and other only buses would produce the same level of output as a single company producing both.
Diseconomies of Scope
When a firm’s joint output is less than that which could be produced by two separate firms, then its production process involves ‘diseconomies of scope’. The possibility occurs if the production of one product somehow conflicts with the production of the other.
Relationship Between Economies of Scale and Economies of Scope
A firm can reap economies of scope even when its production process is undergoing diseconomies of scale. There exists no direct relationship between economies of scale and economies of scope.
Suppose manufacturing a guitar and violin jointly is cheaper than producing both separately. This would mean economies of scope. But the production process involves highly skilled labour and is most economical if undertaken on a small scale. This explains a situation of ‘diseconomies of scale’.
Similarly, a joint-product firm can have economies of scale but not enjoy economies of scope. Let us consider a large business conglomerate which has several firms. If these firms produce efficiently on a large scale, then they enjoy economies of scale. But since they are administered separately, they are not able to enjoy ‘economies of scope.
Degree of Economies of Scope
The degrees of economies of scope (SC) are measured by the percentage of cost savings resulting when two or more products are produced jointly rather than individually.
C(Q1) represents the cost of producing output Q1, C(Q2) represents the cost of producing output Q2, and C(Q1, Q2) represents the joint cost of producing both outputs. The degrees of economies of scope can be represented as:
𝑺𝑪 = 𝑪 (𝑸𝟏) + 𝑪 (𝑸𝟐) − 𝑪(𝑸𝟏 , 𝑸𝟐) / 𝐂(𝐐𝟏 , 𝐐𝟐)
When the physical units of output can be added, as in the car-bus example, we can also write as C(Q1 + Q2). Due to economies of scope, the joint cost is less than the sum of individual costs. Therefore, SC will be greater than 0. When there are diseconomies of scope, SC will be negative. Thus, the larger the value of SC, the greater the economies of scope.
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