4.1.4.4 Economies and diseconomies of scale

When do economies of scale occur?

• fall in average total cost as the scale of production increases

When do Diseconomies of scale occur?

• rise in average total cost as the scale or production increases

When do internal economies of scale occur?

• A fall in avg costs due to growth of the firm

When do external economies of scale occur?

• Fall in average cost due to factors outside of the firm

Economies of scale take a variety of forms, what are they?

Purchasing economies

o Discounts for bulk-buying

Technical economies

o The use of specialist, often expensive, capital e.g. machines

Managerial economies

o Specialist labour e.g. accountants, lawyers, technical

Financial economies

o Better credit ratings as large firms are seen to be less likely to fail and can borrow money at lower interest rates

What is an example of purchasing economies of scale?

Discounts for bulk-buying

• Firms buys a lot - > able to secure lower prices per unit.

• Big firms use influence to get better deals when bulk-buying & better terms when bulk-marketing their own products.

What are technical economies of scale?

• The use of specialist capital e.g. machines

• Large firms spend more on bigger & more efficient machinery

• spread fixed costs over greater output

• obtain lower costs per unit through this method- > increasing competitiveness

• spend more money on scientific Research and technical Development (R&D)

What is meant by managerial economies of scale?

• Employing specialist labour e.g. accountants, lawyers, technical

• Division of labour allows staff to focus on particular areas

• As the employee is allowed to concentrate on a specific job they are likely to be:

• better qualified

• more experienced

• more efficient

• The manager of a small firm will often do the accounts, marketing and look after human resource management issues i.e. a ‘Jack of all trades’

What is meant by external economies of scale?

• A fall in average total cost due to factors outside of the control of the firm.

• They will impact on firms within the same industry or geographical region

• Creating positive externalities

What are examples of external economies of scale?

➢ improved transport infrastructure

➢ a pool of skilled workers

➢ more advanced communication systems

Diseconomies of scale take a variety of forms, what are they?

• Communication

  o Larger firms find it more difficult to communicate efficiently within the organisation

  o There will be an increased cost for communication methods within the firm

  o The manager of a small firm will be able to communicate effectively with all members of the workforce

• Coordination

  o Larger firms find it more difficult to manage the increased number of personnel and customers

  o It might become increasingly difficult to delegate to and motivate

What does higher average costs mean for larger firms?

• discourages them from growing as this could lead to a fall in profits or a move into loss

• The firm will have to weigh up the benefits involved e.g. greater market share against the costs involved e.g. overtrading where the firm takes on too many orders

What does the LRAC curve look like?

Label this diagram

X = outputs

Y = costs

1. Economies of scale

2. Diseconomies of scale

3. Productive efficiency

When do EOS & DEOS operate?

• At the same time

• At first unit costs fall due to economies of scale. At this point economies outweigh diseconomies.

• The optimum output occurs when unit costs are at a minimum (productive efficiency).

• After this unit costs rise and diseconomies outweigh economies.