Economies and diseconomies of scale

What will happen to the scale of output in the long-run

• Its long-run average total costs will initially decrease due to the benefits it receives.

• These benefits are called economies of scale

  • During this period the firm is enjoying increasing returns to scale

What will happen when a firm increases its scale of output in the long-run

• Its LRATC will start to increase at some point

• The reasons for the increase in the LRATC are called diseconomies of scale

  • During this period the firm is facing decreasing returns to scale

Economies of scale

• Financial economies

• Managerial economies

• Marketing economies

• Purchasing economies

• Technical economies

Diseconomies of scale

• Management diseconomies

• Communication diseconomies

• Geographical diseconomies

• Cultural diseconomies

Financial economies

• Large firms often recieve lower interest rates on loans than smaller firms as they are percieved as less risky. A cheaper loan lowers the AC

Managerial economies

Marketing economies

Purchasing economies

Technical economies

Risk-bearing economies

Management diseconomies

Communication diseconomies

Geographical diseconomies

Cultural diseconomies

Minimum efficient scale

• The minimum efficient scale is the lowest cost point on a long-run average total cost (LRATC) curve

  • It represents the lowest possible cost per unit that a firm in the industry can achieve in the long run.

Diagram analysis

• Each subsequent short-run average cost (SRAC) curve represents growth and an increase in size

  • Output increases with each period of growth

• Initially firms experience increasing returns to scale as a result of the economies of scale

• At a certain level of output, the firm will reach the minimum efficient scale where it experiences constant returns to scale

• If it continues to grow beyond that level of output the firm will experience decreasing returns to scale as diseconomies of scale occur

When do external economies of scale occur

• External economies of scale occur when there is an increase in the size of the industry in which the firm operates

  • The firm is able to benefit from lower LRATC generated by factors outside of the firm

Source and explanation