theme 3 : economies of scale

why do firms want to grow

• get more income and your average costs fall

• increase revenue

• increase profit

• to exploit economies of scale (lowers average costs)

• become more efficient

• develop your brand

• influence / exploit subsides or tax breaks to have a positive impact on share price

when firms are taking advantage of economies of scale, what happens to costs

average costs of production are reduced

what is average cost

• cost per unit

• total cost / output

how do we get total costs

sum of all costs

what does each section of an average cost curve mean

• left side of curve - economies of scale

• flat bottom of curve - constant returns to scale / minimum efficiency scale

• right side of curve - diseconomies of scale

6 types of internal economies of scale

• technical

• purchasing

• risk-bearing

• marketing

• financial

• managerial

technical economy of scale explanation

• also called economies of scope

• all about investment in capital equipment

• in order to be more energy efficient

• cost of running machine and maintenance costs low

• doesn’t have to be new machinery, could be technology (e.g. AI)

• also increase your output while decreasing cost per unit

purchasing economy of scale explanation

• reward you get for buying in bulk

• drives down your cost per unit by getting a bulk buy

risk bearing economy of scale explanation

• by a business moving into different industries they can centralise back room operations (e.g. HR, finance department)

• example : virgin has banks, trains, planes, communications and gyms - is a risk to be in all these industries

marketing economy of scale explanation

• as a big business, you can advertise less (already recognisable)

• due to customers already knowing your brand so less effort can be made by the company

• fixed costs so if output doubles, your marketing costs won’t double as well (still same number of adverts being shown)

financial economy of scale explanation

• the bigger you are, the more able you are to drive down interest rates because the money you are borrowing is more

• e.g. 4% of £10bn vs 15% of £10,000

• drives down cost of borrowing

managerial economy of scale explanation

• a manager will deploy the land, labour and capital in a department

• a manager may reorganise a production line to decrease waste and increase output without hiring more employees

• another example is procurement (buying the raw materials you need) e.g. medical equipment for NHS

• managers will buy things while trying to drive down the cost of raw materials

taking advantage of internal economies of scale allows firms to what

move down their average cost curve towards productive efficiency

what do economies of scale cause

cause a barrier to entry to firms wishing to enter the market

3 external economies of scale

• supper re location

• workforce migration

• local / national gov support

supplier re location explanation

• supplier will often move closer to the people they supply as its easier to do business

• this drives down everybody's costs

workforce migration explanation

• example : welsh people in the ‘50s and ‘60s moved to South Yorkshire for the mines

• as a business your cost of recruitment goes down as the talent comes to you and is readily available (63% of undergrads go to London post graduation)

local / national gov support explanation

• super fast networks in cities to support service sector e.g. putting super fast broadband to improve connectivity for a tech sector in London

• introducing infrastructure e.g. the M1 connecting London and Sheffield for faster steel transportation

how does an AC curve move from external economies of scale

• AC curve moves down

• due to a firm benefitting from external economies of scale