3.1.3.4 ECONOMIES AND DISECONOMIES OF SCALE

Define economies of scale

The cost advantage that a firm gains when it expands output leading to a reduction in long run average costs

Define diseconomies of scale

Occurs when a firm expands beyond its optimal size leading to rising long run average costs

Define internal economies and diseconomies of scale

How a firms long run average costs fall and rise when it increases its output

Define external economy of scale

When an industry expands, a firm experiences cost advantages due to improvements in resources and efficiency, this lowers LRAC

Define external diseconomy of scale

When an industry becomes too large, a firm experiences cost disadvantages as competition for resources increases, this increases LRAC

In simply terms, define what happens to efficiency when:

• industry grows

• industry grows too much

Industry grows - more efficient - costs fall (economies)

Industry grows too much - less efficient - costs rise (diseconomies)

Why are cost curves U shaped?

• it falls at first due to economies of scale

• it reaches minimum point (the most efficient level of output)

• it rises due to diseconomies of scale

When does the law of diminishing returns set in on a curve?

At the lowest point

What does the law of diminishing returns mean?

Adding more of one input - less additional output each time

At low levels of output, what do firms benefit form?

Increasing returns to scale and economies of scale

When diminishing reruns sets in, what happens to cost?

Costs rise faster than output, average costs start to increase

When the law of diminishing returns set in, what happens to workers productivity?

Labour becomes less productive

Why can multiple SRAC curves fit into 1 LRAC curve?

Each curve associates with a different scale of capacity that is fixed in the short run

At low levels of output, what do firms do?

• specialize labour

• use efficient technology

(So output rises faster than costs and average costs fall)

At high levels of output, what do firms experience?

• communication problems

• co-ordination problems

• lower work motivation

(So now cost rise faster than output, so average costs increases)

Summarize internal economies of scale +examples

• cost advantages arise within a firm as it increases its own output

• eg, bulk buying, specialization

Summarize external economies of scale +examples

• cost advantages that arise outside the firm, due to the growth of the whole industry

• eg, better infrastructure, skilled labour, supplier networks

What are volume economies?

Larger scale of production, allows use of machinery and automation and bulk buying

What is another name for volume economies?

Technical economies

What can economies of massed resources do?

Bulk buy raw materials (discounted price, better deals with suppliers)

What are integration economies?

Occurs when a firm controls multiple stages of production

What are managerial economies of scale?

Large firms can divide management into specialized roles, improving productivity

What are marketing economies of scale?

Advertising and promotion costs can be spread over a large volume of sales

What are financial or capital-raising economies of scale?

Large firms can raise finance through lower interest rates on loans and greater investor confidence

What are risk-bearing economies of scale?

Large firms can spread risk by diversifying risk and operating in multiple countries

What are economies of scope?

Firms share resources like technology, marketing and distribution systems

What are managerial diseconomies of scale?

As a firm grows, management structures become more complex, this means decision making slows down

• co-ordination becomes a struggle

What is communication failure (in terms of internal diseconomies of scale)?

In larger firms, communication becomes slower, distorted, and less effective - leading to mistakes, delays and inefficiencies

What are motivational diseconomies of scale?

Workers in large firms may feel less valued, less connected to th business

• this leads to lower morale and productivity

Summarize external economies of scale?

• cost advantages that a firm gains due to the growth of the industry

• leads to lower average costs

• eg, improved infrastructure, skilled labour pool, specialist suppliers, shared knowledge

Summarize external diseconomies of scale?

• cost disadvantage that arise when an industry becomes too large

• leads to higher average costs

• eg, competition for resources, delays in transport, rising rent/land costs