DP BM 1.5.1 - Economies and Diseconomies of Scale

economies of scale

lower average cost of production due to increase in production efficiency in large scale firms

average cost (AC)

• cost per unit output

• AC = TC (total cost) / Q (quantity of output)

two types of average cost (definition + equation)

• Average Fixed Cost (AFC) = TFC (total fixed cost)/Q

• Average Variable Cost (AVC) = TVC (total variable cost) /Q

optimal level of output

when average costs are minimized

internal economies of scale

economies of scale that occur within the firm and the firm’s control

7 types of internal economies of scale + short definition

• technical (machinery → mass production)

• financial (borrow large sums of money with less interest)

• managerial (employ specialized managers)

• specialization (division of workforce labor to be more specialized)

• marketing (can sell in bulk)

• purchasing (can purchase at bulk discounts)

• risk-bearing (can offset unfavorable conditions in one industry with another, enjoyed by conglomerates)

conglomerate

large corporation with several smaller companies in different industries, operating as a single unit with diversified business units

How is specialization significant?

it increases productivity

external economies of scale (def. + example)

• factors of growth that are outside the biz.

• ex. location, industry growth

4 types of external economies of scale

• technological progress (industry-wide advancements→ increase in productivity)

• improved transportation networks (→ prompt deliveries)

• abundance of skilled labour (usually in a region → cuts recruitment cost)

• regional specialization (→ specialist suppliers and labour, can charge premium prices)

diseconomies of scale

when average unit costs begin to rise as a firm grows too large and inefficient

what causes internal diseconomies of scale?

occurs due to mismanagement

4 types of internal diseconomies of scale

• lack of control, coordination and communication

• poorer working relationships + staff alienation → lower staff morale and productivity

• increased bureaucracy → slows decision making

• complacency (lack of awareness of genuine risks and deficiencies)

bureaucracy

a system of managing organizations characterized by a strong hierarchy and complex rules and procedures

external diseconomies of scale

increase in AC caused by factors beyond a firm’s control

3 main types of external diseconomies of scale

• scarcity of resources (higher rent cost)

• increased labour costs (higher pay to retain employees)

• traffic congestion (delivery delays + higher transport costs)