Economies and Diseconomies of Scale

What are economies of scale?

A reduction in long run average costs as output increases.

What is the formula for average costs( AC)

AC = Total costs/ quantity

Why do average costs fall with increase in output?

An increase in output will result in the total cost increasing, but the quantity will increase at a greater rate. Therefore, average costs will fall.

What are internal economies of scale?

Internal economies of scale occur within a business, who are then free to exploit them.

What are the internal economies of scale?

1. Risk bearing

2. Financial

3. Managerial

4. Technical

5. Marketing

6. Purchasing

What are risk-bearing economies of scale?

Larger firms will be able to spread their risks over their business. Considering that a risk equates to a cost, firms that take more risks will, therefore, obtain a higher total cost. However, these costs can be spread over the large scale of output, allowing the long-run average cost to fall.

What are financial economies of scale?

Firms that are growing will be able to compete for lower interest rates with banks. This is because the banks, acknowledging that the company is to be a proven success, will be more willing to offer lower interest rates because it is in their own future interest to do business with such firms.

What are managerial economies of scale?

Growing firms will be more willing and able to hire more specialists( managers) of their chosen field. This is because the implementation of such individuals will promote further growth for the company. However, employing such managers will mean paying them greater salaries, which will, therefore, contribute to a higher total cost. Despite this, the quality and the quantity of production that these specialists offer will be greater than the costs, which can then be spread over a large range of productivity.

What are technical economies of scale?

Growing firms will be more willing and able to employ specialist capital( machinery) and workers to promote further firm growth. However, the implementation of such high-quality labor and machinery will require greater resources and funds to pay for the salaries( of workers) and maintenance( of machinery). Despite this, the quality and quantity of production will exceed these costs, allowing the costs to spread over a large range of output, contributing to lower long-run average costs.

What are marketing economies of scale?

Growing firms will be more willing and able to fund greater advertising in major, populated cities. This is because more consumers will be attracted to the goods and services of the business, inviting more revenue and profits. However, to carry out this process, the firm must first pay for the required funds, which will, therefore, contribute to a higher total cost. However, as I mentioned before, the revenues and profits gained from the advertising will be greater than the costs. This will contribute to lower long-term average costs.

What are purchasing economies of scale?

Growing firms require resources and raw materials to support their expansion. Therefore, such businesses would look to buy supplies in bulk to avoid paying the full price but a lower unit price. This is because the unit price of the good in bulk will be less.

What are external economies of scale?

External economies of scale are out of the business's control and manipulation, but can still benefit the large firm by reducing long-run average costs with an increase in output.

What are examples of external economies of scale?

1. Suppliers will look to move closer to the firm because it's in their interest to fund a large corporation. This is beneficial to the company because transport costs will decrease, allowing the firm to invest in more capital and further firm growth.

2. Roads and networks will be built to connect the firm with major, populated cities because the corporation is a key sector in the area. This is very advantageous to the company because it will be more convenient to exchange raw materials and resources. Additionally, more consumers will be invited to purchase the goods and services offered by the firm because it's more favourable for them to access the firm.

3. Research and development firms will look to move closer to the firm because it's in their interest to provide for a larger corporation. This will, therefore, allow the company to acknowledge what goods and services are, or will be, in high demand or fashion. This means that the company will be able to gain more revenue and profits, funding further firm growth.

What are diseconomies of scale?

An increase in average costs with an increase in output.

What are the causes of diseconomies of scale?

1. Control

2. Communication

3. Coordination

4. Motivation

How is control a cause of diseconomies of scale?

It will be more arduous for the managers of a larger firm to monitor and control each employee. Workers, acknowledging the lack of supervision, will begin to slack off and be less productive in the long term, causing the long-run average costs to rise.

How is communication a cause of diseconomies of scale?

It will be more difficult for workers of a large firm to pass information or share their knowledge with people higher in the hierarchy. For example, say an employee has an ingenious idea to improve the productivity efficiency rate of the organisation, but they find it arduous to pass this vital information to the Directors and CEO, an essential opportunity will pass, causing the firm to operate in the same, unproductive manner. This will, therefore, contribute to higher long-term average costs.

How is coordination a cause of diseconomies of scale?

The purchasing sector of the firm will find it difficult to communicate with the marketing sector, for example, because both departments are located in different spaces of the organisation. Therefore, it will be difficult for a large firm to operate in unison as each aspect of the company is situated in different locations of the corporation. This will cause productivity rates to fall, contributing to greater long-term average costs.

How is motivation a cause of diseconomies of scale?

Low-level employees of the hierarchy system of the large firm will begin to acknowledge their lack of value to the company. This is because workers are more easily dispensable, as other aspiring applicants can demonstrate their skills and take on their positions. Therefore, these workers will begin to feel less motivated, and their productive efficiency will begin to fall. If this occurs at a large scale across the company, long-run average costs will rise.