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Also known as MES, a minimum efficient scale is the smallest production output that a business can maintain and still keep the long-run average total cost within an acceptable range. Identifying the range for this scale is helpful in aiding a business in determining how it should respond to the demand for the products produced. Ideally, the company is able to meet that demand consistently while incurring costs that still allow the company to produce an equitable amount of profit.
The scope of the minimum efficient scale is often dictated by the size of the market where the company seeks customers, and how many other companies produce similar goods and compete for those same customers. Within the marketplace, the overall demand for the type of products produced by all the companies competing in the market help to provide some sense of how many units a business can produce without building up a large inventory that moves at an extremely slow rate. Internally, the company looks at all costs associated with producing and storing the goods until they are sold. Often, the costs of marketing, public relations, and shipping is also taken into account.
In calculating the costs associated with the task of meeting consumer demand, the company will consider both fixed and variable costs. Depending on the industry involved, the minimum efficient scale may be somewhat high if there is a high amount of fixed costs in comparison to the variable costs connected with the operation. When this is the situation, there is a good chance that a relatively small number of companies compete for consumers, and the opportunities for acquiring larger market share are somewhat limited. If the scale is somewhat low, there is a good chance that there is a number of companies competing for consumers, and plenty of opportunity for competition.
The minimum efficient scale is all about identifying the ideal balance between demand, production, and the costs associated with production and delivery of the products. Should the costs of production be so high that it is impossible to sell the products at a competitive price and still earn a profit, the business will ultimately fail. If the demand for the products decreases significantly, the scale will also shift to reflect that chance in demand, and may result in undermining the ratio between costs and profits. Since many industries do experience shifts in demand from time to time, and the costs of production may increase or decrease, identifying the current minimum efficient scale is an ongoing task.