The optimal size to be…

There are many ways to attempt to answer the question of “What is the optimal size for my business?” Today I will present you with a simple economic model that might help shed light in this conundrum.

Suppose you are choosing between three different store fronts: Space x, space y and space z. Individually, they each yield their own average total cost curve (i.e.  a function that shows the monetary value associated with average cost per unit for different levels of output). We understand the rent for example for each of those spaces is different, but an optimal decision maker doesn’t solely pick the cheapest. Perhaps the spaces have different characteristics that may be important to the production process (e.g.  space).

Since all of the plotted ATCs are associated with a rent space, and the space itself does not vary with quantity, this is what economists call a fixed cost. But ultimately, the decision of which space to get is essentially a decision of which average total cost is preferred for your business model. Notice on the graph I drew, each quantity is associated with structure that ultimately generates a minimum cost. Moreover, the structure associated with set cost changes when quantity changes. Therefore, establishing the “optimal size to be” is inherently associated with one’s projections regarding quantity demanded.

The best space is the space is generates the minimum cost for the expected quantity demanded.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s