These occur when mass producing a good results in lower average cost. Economies of scale occur within an firm (internal) or within an industry (external).
Average costs fall per unit – Average costs per unit = total costs / quantity produced
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.
External Economies of Scale - Are those shared by a number of businesses in the same industry in a particular area.
Types of Internal Economies of Scale
Below are types of internal economy of scale
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
These are advantages gained for the whole industry, not just for individual businesses.
For Example:
- 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.
- Reputation
Diseconomies of Scale
Occur when firms become too large or inefficient. Average costs per unit start to rise. Below are the types of diseconomy of scale and some examples
Communication
- When firms grow there can be problems with communication
- As the number of people in the firm increases it is hard to get the messages to the right people at the right time
- In larger businesses it is often difficult for all staff to know what is happening
Coordination and control problems
- As a business grows control of activities gets harder
- As the firm gets bigger and new parts of the business are set up it is increasingly likely people will be working in different ways and this leads to problems with monitoring
Motivation
- As businesses grow it is harder to make everyone feel as though they belong
- Less contact between senior managers and employees so employees can feel less involved
- Smaller businesses often have a better team environment which is lost when they grow
Economies of Scale & Monopolies
- Economies of scale can lead to the development of monopolies as larger businesses are able to exploit lower unit costs and therefore make more profits
Minimum efficient scale
- Where an increase in the scale of production gives no benefits to a reduction in unit costs
- This is the point where production is sufficient for internal economies of scale to be fully exploited
- Minimum efficient scale is seen as the lowest point on the long run average cost curve
- The MES depends on a number of factors including: Ratio of fixed to variable costs If a natural monopoly exists
Minimum efficient plant size - Where an increase in the scale of production of an individual plant within the industry doesn’t result in any unit cost benefits
Economies of Scale & Barriers to Entry
Economies of scale can act as a barrier to entry for firms into a market
This is because economies of scale allow a firm to have a lower cost structure and therefore can decrease prices if a new firm enters the market eventually driving them out
