economies of scale

Define economies of scale

Economies of scale are the cost advantages a firm experiences as it increases production, leading to a fall in long-run average cost (LRAC) per unit of output.

internal economies of scale

refers to any cost/ saving benefit that only effects the one firm that has grown

e.g a company upgrading their office through deciding to invest in an elevator

External economies of scale

refers to any cost/saving benefit that effects every firm in the industry

e.g the introduction of fiber optic cables benefits every broadband company

Types of Economies of Scale

Internal Economies of Scale (arise within the firm)

-Technical:

Larger machines or production processes are more efficient

e.g Using assembly lines in car production

-Managerial:

Specialization of managers reduces inefficiency

e.g HR, finance, operations departments

-Financial:

Big firms can borrow at lower interest rates

e.g Large firms vs small startups

-Marketing:

Spreading advertising over large output reduces cost per unit

e.g National campaigns for Coca-Cola

-Purchasing / Bulk buying:

Discounts from buying raw materials in large quantities

e.g Supermarkets buying stock in bulk

Types of Economies of Scale

External Economies of Scale (arise from growth of the industry or market)

-Skilled labour:

--More trained workers available locally

e.g Silicon Valley tech workers

-Infrastructure:

--Better transport, utilities, and supplier networks reduce costs

e.g Ports and roads for manufacturing hubs

-Ancillary services

--Specialized firms emerge to support industry

e.g Legal, accounting, marketing services for financial firms

Importance of Economies of Scale

1. Lower Average Costs

--As output ↑, long-run average cost (LRAC) ↓.

--Makes firms more efficient and able to produce at lower unit cost.

--Important in competitive markets where price competition is strong.

2. Price Competitiveness

--Lower costs → firms can cut prices without cutting profit margins.

--Increases market share and consumer welfare.

--Example: Aldi & Lidl use bulk buying to offer lower prices.

3. Higher Profits

--Firms may keep prices stable but enjoy higher profit margins.

--Profits → reinvestment (R&D, innovation, expansion).

4. Barriers to Entry / Market Structure

--Large firms benefit most → new entrants may struggle.

--Explains why some industries (airlines, supermarkets, utilities) are oligopolies or natural monopolies.

5. Global Competitiveness

--Firms with EOS can compete internationally.

--Example: China's manufacturing industry benefits from huge scale → lower global prices.

6. Innovation & R&D

--Larger firms with EOS → more retained profits → fund research, improve products.

--Example: Apple, Amazon investing in new tech.

7. Consumer Benefits

--Lower prices.

--Wider range of products (due to marketing economies).

--Better quality due to investment in technology.

Diseconomies of scale

Diseconomies of scale occur when a firm becomes too large and its long-run average cost (LRAC) starts to rise as output increases.

causes of diseconomies of scale

-Managerial / Coordination problems:

--As firms grow, it becomes harder to organize production efficiently.

--Too many layers of management → slower decision-making.

-Communication problems:

--Large firms may suffer from poor communication between departments

→ mistakes and delays.

-Worker alienation / motivation issues:

--In very large firms, workers may feel less valued → lower morale → lower productivity.

-Bureaucracy:

--Large organizations require more admin → inefficiency and higher costs.

-Geographical diseconomies:

--If firms expand to multiple locations, transport and logistics costs may rise.

diagram + labels

U-shaped LRAC curve:

Downward slope → economies of scale.

Bottom → minimum efficient scale (optimum size).

Upward slope → diseconomies of scale.

Label:

Downward slope = Economies of scale.

Lowest point = MES.

Upward slope = Diseconomies of scale.

explain the movements in the Long-Run Average Cost (LRAC) curve

Downward Slope (Economies of Scale):

-As output ↑, LRAC ↓.

-Firms exploit internal economies of scale:

--Technical economies (better machinery).

--Purchasing economies (bulk buying).

--Managerial economies (specialisation of labour/management).

--Financial economies (cheaper loans).

Costs fall → greater efficiency.

Flat / Constant Section (Minimum Efficient Scale):

-Point where LRAC is at its lowest.

-Known as the minimum efficient scale (MES).

-Firms produce at the lowest average cost per unit.

-Important for competitiveness → firms operating at MES can undercut rivals.

Upward Slope (Diseconomies of Scale):

-Beyond MES, further expansion causes LRAC to rise.

-Diseconomies of scale set in:

--Coordination/communication difficulties.

Bureaucracy.

--Worker motivation falls.

--Firm becomes less efficient as it grows too large.

consequences of diseconomies of scale

-Higher unit costs → lower competitiveness.

-Reduced profits if costs rise faster than revenue.

-May cause firms to downsize or restructure.

Evaluation

-Not inevitable → some firms (e.g. tech giants) avoid diseconomies through good management and digital efficiency.

-Depends on industry → service-based firms may experience diseconomies earlier than capital-intensive firms.

-Government intervention (infrastructure, training) can reduce external diseconomies.

-Economies of scale may still outweigh diseconomies in some sectors → explains natural monopolies (e.g. utilities).