5.1: Economies and diseconomies of scale

economies of scale

economies of scale

• large firms produce goods more cheaply than small firms

• the size of a firm affects cost of production

• increased firm size = falling average costs

diseconomies of scale

• beyond 70000 units, average costs start to rise

• average costs rise in larger firms due to inefficiency

internal economies of scale

falling average total costs as output increases

sources of internal economies of scale

• purchasing economies

• marketing economies

• technical economies

• financial economies

• risk-bearing economies

• managerial economies

purchasing economies

• large firms buying lots of resources get cheaper rates

• suppliers offer discounts to firms that buy raw materials and components

• bulk buying = better value for money

marketing economies

• fixed marketing costs

• cheaper to buy assets than outsource

• costs spread over more units of output

• average cost of advert is smaller for larger firms

technical economies

• larger plants are more efficient than smaller ones

• more specialisation and investment in machinery

financial economies

• larger firms have wider product ranges

• sell in a wider variety of markets

• reduces risk

external economies of scale

all firms in an industry enjoy falling average costs as the industry grows in a particular region

sources of external economies of scale

• skilled labour

• infrastructure

• ancillary and commercial services

• cooperation

skilled labour

• build up of labour with skills and experience requiredd by an industry concentrated in one argue

• lower training costs during recruitment

• vocational courses provided by local institutions for industry

infrastructure

roads, railways, ports, buildings and other facilities suit the need of a particular industry when it’s dominant

ancillary and commercial services

established industries encourage ancillary suppliers to set up and all firms benefit

cooperation

firms in the same industry located close to each other cooperate for gain

diseconomies of scale

average costs rise is a firm continues to expand beyond a certain point as aspects of production become inefficient

sources of diseconomies of scale

• bureaucracy

• labour relations

• control and coordination

bureaucracy

• larger businesses rely on bureaucracy

• many resources are used in admin if a business becomes too bureaucratic

• decision making becomes slow

• long communication channels

• wasted resources = rising average costs

labour relations

• relations between workers and managers deterioriate if a firm becomes too big

• management fails to understand workers

• workers become demotivated

• conflicts occur

control and coordination

• large businesses are difficult to control and coordinate

• demanding

• need for more supervision

• raised costs

barriers preventing a business from growing

• lack of finance

• market nature

• lack of managerial skills

• lack of motivation

lack of finance

• businesses are unable to raise finances need to expand

• growth required investment

• moneylenders can’t be convinced that the finance borrowed will be repaidd

• risky

market nature

some markets are too small to sustain large companies

lack of managerial skills

some owners may not have the managerial and delegate skills required for a large business operation

lack of motivation

some owners may be happy with profit satisficing and have other interests requiring time and flexibility