3.3.3 Economies and diseconomies of scale

ECONOMIES OF SCALE

• EoS- advantages of large scale production that enable a large business to produce at a lower average cost than a smaller business

• so firm is able to experience increasing returns to scale where an increase in inputs by a certain % will lead to a greater % increase in output

DISECONOMIES OF SCALE

• DoS- disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise

• firm experiences decreasing returns to scale, where output increases by a small % than inputs

CONSTANT RETURNS TO SCALE

• where firms increase inputs and receive an increase in output by the same %

MINIMUM EFFICIENT SCALE

• minimum level of output needed for a business to fully exploit economies of scale

• point where LRAC curve first levels off and when constant returns to scale is first met

INTERNAL ECONOMIES OF SCALE

• advantage that a firm is able to enjoy because of a growth in firm, independent of anything happening to other firms or industry in general

TYPES OF INTERNAL ECONOMIES OF SCALE- TECHNICAL ECONOMIES

• technical economies

  • specialisation

  • balanced teams of machines

  • increased dimensions

  • invisibility of capital

  • research and development

TYPES OF INTERNAL ECONOMIES OF SCALE- OTHER ECONOMIES

• financial economies

• risk-bearing economies

• managerial economies

• marketing and purchasing economies

  • buying in bulk

  • specialisation

  • distribution

TECHNICAL ECONOMIES

• arise as a result of what happens to production process

TECHNICAL ECONOMIES- SPECIALISATION

• large firms will be able to appoint specialist workers and buy specialist machines which will be able to do their jobs more quickly and better than machines/workers which are not specialised

TECHNICAL ECONOMIES- BALANCED TEAMS OF MACHINES

• large firms can afford to buy a no. of every kind of machine for each stage of production

• by combining these machines, they can ensure they run each machine at its optimal level

• smaller companies may only be able to afford one machine for each stage and if one stage of production runs faster than the other, machines will spend a long time turned off

TECHNICAL ECONOMIES- INCREASED DIMENSIONS

• if you double the size of a container you increase the amount it can carry

• all occurs w/out doubling the cost

• spend less of shipping costs

TECHNICAL ECONOMIES- INVISIBILITY OF CAPITAL

• some processes require huge items of machinery and investment that make it only possible for them to produce on a large scale

TECHNICAL ECONOMIES- RESEARCH AND DEVELOPMENT

• often only large firms can afford to carry out large scale R&D

• means they can gain a large advantage over their competitor

FINANCIAL ECONOMIES

• large firms have greater security because they have more assets and are therefore less likely to be forced out of business overnight

• so easier for them to obtain finance and lower interest rates due to lower risk

• makes investment more accessible

RISK BEARING ECONOMIES

• large companies able to operate in a range of diff markets, producing diff products which means that if one area of business fails, their whole business will not collapse

MANAGERIAL COMPANIES

• large companies can afford to appoint specialist managers in every field, who are specialised and so are likely more efficient

• staff represent an indivisibility and so small firms cannot employ specialist staff

PURCHASING ECONOMIES- BUYING IN BULK

• large firms able to buy in large no. so may be able to buy their raw materials at a cheaper price than competitors

MARKETING AND PURCHASING ECONOMIES- SPECIALISATION

• businesses can afford to take on specialist buyers and sellers who could be more efficient due to extra time and knowledge

MARKETING ECONOMIES- DISTRIBUTION

• large businesses can establish regional distribution centres which enables them to reduce transport costs by using large transporters over long distances and storing goods in distribution centre

EXTERNAL ECONOMIES OF SCALE

• advantage which arises from growth of industry w/in which the firm operates, independent to firm itself

• cause the LRAC curve to shift downwards

EXTERNAL ECONOMIES OF SCALE- HIGH CONC OF FIRMS IN AN AREA

• businesses established in an area w/ other successful firms from same industry find that labour tends to come to that area if they want a job in that industry

• e.g. Silicon Valley

• reduces cost and time take to recruit

EXTERNAL ECONOMIES OF SCALE- SKILL IMPROVEMENT

• local education and training providers are more likely to develop courses to prepare people to take up jobs in these businesses

• firms be able to hire staff who have been trained by other businesses, which is cheaper and more efficient for the firm than training the workers themselves

EXTERNAL ECONOMIES OF SCALE- SUPPORT SERVICES

• businesses who provide products or services for large businesses will naturally move to area where those businesses are based, which reduces transport cost/time delays for business

DISECONOMIES OF SCALE- TYPES

• workers

• geography

• change

• price of materials

• management

DISECONOMIES OF SCALE- WORKERS

• in a large business, people can think their efforts go unnoticed and have less chance of promotion so lose motivation and work less hard

• can also have less personal commitment w/ the business

DISECONOMIES OF SCALE- GEOGRAPHY

• firm may have to transport finished products huge distances and firms may find it harder to control parts of business which is miles away

DISECONOMIES OF SCALE- CHANGE

• takes longer and is more difficult for a large firm to respond to change

DISECONOMIES OF SCALE- PRICES OF MATERIALS

• as business grows so does their demand for raw materials and equipment

• although this can increase their bargaining power as they buy in bulk, an increase in demand can cause prices to rise and therefore increase production costs

• this could also occur if whole industry increases and so firms bid up prices

DISECONOMIES OF SCALE- MANAGEMENT- COORDINATION AND CONTROL

• as a business grows, it will become progressively more difficult to coordinate and control of all diff parts of business

• could lead to poorer quality to work and business decisions which don’t work well together

DISECONOMIES OF SCALE- MANAGEMENT- COMMUNICATION

• w/in a large business, communication can be slow and lose accuracy because of distance and no. of people it has to be passed through