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

firms with diversified portfolio of products in different markets

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)