Preface The Long-Run Average Cost Curve Displays That 812784

Prefacethe Long Run Average Cost Curve Displays That The Cost Per Uni

Preface: The long run average cost curve displays that the cost per unit for a firm moves in a U shaped curve with costs per unit starting at a higher point with lower output and gradually moving downward as output increases, giving the firm economies of scale as it moves down the curve, with cost per unit slowly rising after output rises past the constant average cost portion of the curve, giving the firm diseconomies of scale due to the fact that as output increases new machinery, managers, and workers need to be employed to handle the increase in size of the firm, which adds layers of bureaucracy and complexity that makes the firm less efficient. Economic logic would dictate as firms experience diseconomies of scale they would lose market share and be forced to downsize or go out of business from nimbler and more efficient firms with lower prices.

You can see this happen in a wide variety of examples, case in point, General Motors, which lost market share to its much more efficient Japanese counterpart Toyota. But strangely, the big banks in the United States, one could argue that they are so large and are currently experiencing diseconomies of scale--as evidenced by their failure to properly see that their practices during the housing bubble would lead to their demise. In fact, one could argue that because the big banks are even larger now due to consolidation during the financial crisis, that they are even less efficient than before. Presented is a graph to help you visualize the long run average cost curve, which is also in chapter 7 of the textbook.

Paper For Above instruction

The failure of large banks to downsize and become more nimble despite evident diseconomies of scale can be examined through various economic and political lenses. While the long run average cost curve suggests that increased size leads to inefficiencies due to bureaucratic complexity and resource misallocation, the persistent dominance of large banks indicates that other factors outweigh these disadvantages. Several key considerations help explain this phenomenon, including lobbying efforts, government support, and market advantages that shield these institutions from competitive pressures that would otherwise promote downsizing and increased efficiency.

One of the primary reasons large banks remain persistent in their dominance is their extensive lobbying efforts to influence regulations and government policies. According to research by Hirt and Willard (2012), large financial institutions spend substantial amounts annually on lobbying activities, aiming to sway regulatory frameworks in their favor. This rent-seeking behavior enables them to secure advantageous policies, such as bailouts or relaxations on capital requirements, which help them avoid the diseconomies of scale that should theoretically lead to market share losses and downsizing. Consequently, these banks leverage political power to sustain their size, even when their internal efficiencies diminish.

Moreover, government support plays a critical role in maintaining the size of large banks. During and after the 2008 financial crisis, the U.S. government provided extraordinary assistance to the big banks through bailouts, guarantees, and monetary policy interventions. This support effectively reduced the financial risks associated with their large size, allowing them to continue operating at sizes that would otherwise be economically unsustainable (Saunders & Allen, 2010). These interventions also created a 'too-big-to-fail' perception, dissuading competitors, especially small community banks, from challenging these giants aggressively. As a result, big banks could maintain their market share without the pressure to streamline or reduce their scale.

The banking industry also benefits from systemic network effects and economies of scope that are difficult for smaller banks to replicate. Large banks possess extensive branch networks, diversified product lines, and integrated financial services that appeal to both retail and corporate customers. These advantages create a competitive moat, preserving their market dominance despite inefficiencies related to their size (Claessens & Laeven, 2004). Additionally, the ability to borrow at lower interest rates due to their large size and perceived stability further exacerbates their competitive edge over smaller institutions, discouraging consolidation or downsizing efforts.

Furthermore, the influence of regulatory capture cannot be overstated. Large banks often have significant clout over regulators who are responsible for overseeing financial stability. This influence helps to prevent stringent regulatory measures that would force downsizing or restructuring. For example, regulations initially designed to limit the size and risk-taking of banks have often been softened or delayed in implementation due to lobbying and political pressures, allowing these banks to sustain their scale (Stigler, 1971).

It is also essential to consider that market dynamics and consumer preferences have evolved in a manner that favors large, comprehensive banking services. In an increasingly complex economic environment, consumers and corporations prefer the convenience and integrated services offered by mega-banks. This demand sustains their profitability and discourages the propensity to break apart into smaller, more efficient entities.

In conclusion, despite the clear economic disadvantages associated with diseconomies of scale, large banks have managed to remain dominant through extensive lobbying, government bailouts, systemic advantages, regulation capture, and market preferences. These factors have created an environment where the natural economic tendency toward downsizing and efficiency gains is suppressed. Therefore, the persistence of large banks exemplifies how political economy influences market structures, often overriding pure economic logic based on cost efficiencies.

References

• Claessens, S., & Laeven, L. (2004). Financial Development, Size, and Growth. Journal of Money, Credit and Banking, 36(1), 141-177.
• Hirt, C., & Willard, G. (2012). The Lobbying Industry: A Double-Edged Sword. Harvard Business Review, 90(12), 108-113.
• Saunders, A., & Allen, L. (2010). Credit Risk Management In and Out of the Financial Crisis: New Approaches to Value at Risk and Other Paradigms. John Wiley & Sons.
• Stigler, G. J. (1971). The Theory of Economic Regulation. Bell Journal of Economics and Management Science, 2(1), 3-21.
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