Economies of Scale

Economies of Scale

These occur when mass producing a good results in lower average cost.

Average costs fall per unit – Average costs per unit = total costs / quantity produced

Economies of scale occur within an firm (internal) or within an industry (external).

Internal Economies of Scale

• As a business grows in scale, its costs will fall due to internal economies of scale.
• An ability to produce units of output more cheaply.

There are many types of internal economy of scale. Below is a list and examples of each.

Production / Technical Economies

• Larger firms can use computers / technology to replace workers on a production line
• Mass production lowers cost per unit
• Large scale producers can employ techniques that are unable to be used by a small scale producer.
• Able to transport bulk materials.

Purchasing / Marketing Economies

• Advertising costs can be spread across products
• Large businesses can employ specialist staff
• Bulk buying – if you buy more unit cost falls

Financial Economies

• Larger firms have better lending terms and lower rates of interest
• Easier for large firms to raise capital.
• Risk is spread over more products.
• Greater potential finance from retained profits.
• Administration costs can be divided amongst more products

Managerial Economies

• More specialised management can be employed, this increases the efficiency of the business decreasing the costs

Risk-bearing Economies

• Large firms are more likely to take risks with new products as they have more products to spread the risk over

External Economies of Scale

Are those shared by a number of businesses in the same industry in a particular area.

These are advantages gained for the whole industry, not just for individual businesses.

Examples:

• As businesses grow within an area, specialist skills begin to develop.
• Skilled labour in the area – local colleges may begin to run specialist courses.
• Being close to other similar businesses who can work together with each other.
• Having specialist supplies and support services nearby