Unit 2 - Business Economics: Chapter 17: Economies and Diseconomies of Scale

Economies and Diseconomies of Scale

Learning Objectives

  • Define economies of scale and internal economies of scale.

  • Understand the long-run average cost curve and the impact of economies and diseconomies of scale on its shape.

  • Understand the types of internal economies of scale: purchasing, marketing, technical, financial, managerial, and risk-bearing.

  • Define external economies of scale.

  • Understand the types of external economies of scale: skilled labor, infrastructure, access to suppliers, similar businesses in the area.

  • Define diseconomies of scale.

  • Understand the types of diseconomies of scale: bureaucracy, communication problems, lack of control, and the distance between top management and workers.

Subject Vocabulary

  • Scale: Size of a business.

Getting Started

  • Businesses often want to grow to increase their scale.

  • Increasing scale can lead to certain costs falling.

Economies of Scale

  • Large firms can usually produce goods more cheaply than small firms.

  • Average costs fall as a firm increases in size due to economies of scale.

  • Figure 17.1 illustrates this concept, showing average cost decreasing with increased output up to a certain point.

  • Example:

    • 20,000 units: Average cost is US$25.

    • 40,000 units: Average cost falls to US$15.

    • 70,000 units: Average costs are minimized at US$10 per unit (ideal size).

  • If the firm grows beyond 70,000 units, average costs will start to rise due to diseconomies of scale.

  • Example:

    • 90,000 units: Average costs rise to US$12.50 per unit.

Subject Vocabulary

  • Economies of Scale: Falling average costs due to expansion.

  • Diseconomies of Scale: Rising average costs when a firm becomes too big.

Internal Economies of Scale

  • Cost benefits that an individual firm can enjoy when it grows.

  • Figure 17.2 summarizes the sources of internal economies of scale:

    • Purchasing Economies

    • Marketing Economies

    • Technical Economies

    • Financial Economies

    • Managerial Economies

    • Risk-Bearing Economies

Purchasing Economies

  • Large firms get cheaper rates due to bulk buying.

  • Suppliers offer discounts for large quantity purchases.

  • GF Foods example: Buying bread at US$1.10 a loaf compared to Gilly's Snack Shack paying US$1.80.

Subject Vocabulary

  • Bulk Buying: Buying goods in large quantities, which is usually cheaper.

Marketing Economies

  • Cost-effective to run own delivery vehicles for large firms.

  • Fixed marketing costs (e.g., TV advert) are spread over more units, reducing average cost.

Technical Economies

  • Larger factories are often more efficient.

  • More specialization and investment in machinery.

  • Example: A large engineering company using CAD software every day versus a small company using it one day a week.

Financial Economies

  • Large firms can access money more cheaply and have a wider variety of sources.

  • Can raise money by selling shares (not available to sole traders).

  • Banks offer lower interest rates to large companies.

  • GF Foods example: Paying 7.5% to borrow US$1 million, while Gilly's Snack Shack pays 8.9% to borrow US$5,000.

Managerial Economies

  • Larger firms can afford specialist managers.

  • Specialists improve efficiency and reduce average costs.

Risk-Bearing Economies

  • Larger firms have wider product ranges and sell into more markets, reducing business risk.

  • Example: Supermarkets extending product ranges.

External Economies of Scale

  • Cost benefits that all firms in an industry can enjoy when the industry expands.

  • More likely to occur if an industry is concentrated in a particular region.

Skilled Labour

  • Concentrated industries may build up skilled labor, reducing training costs.

  • Local schools and colleges provide vocational courses.

Infrastructure

  • Roads, railways, ports, and buildings shaped to suit the industry's needs.

  • Specialized industrial estates may be developed.

Access to Suppliers

  • Established industries attract specialist suppliers (marketing, cleaning, banking, etc.).

  • Example: Car industry in the Midlands, England.

Similar Businesses in the Area

  • Firms cooperate and share costs/benefits (e.g., research and development centers).

  • Example: High-tech businesses in Silicon Valley, California.

Diseconomies of Scale

  • Average costs rise if a firm continues to expand beyond a certain point.

  • Aspects of production become inefficient.

Bureaucracy

  • Too many resources used in administration.

  • Slow decision-making and long communication channels.

General Vocabulary

  • Bureaucracy: A system of administration that uses a large number of departments and officials.

  • Coordinate: To organize people or things so that they work together well.

Communication Problems

  • Large organizations spread all over the world.

  • Different languages, cultures, and time differences.

Lack of Control

  • Difficult to control and coordinate large businesses.

  • Need for more supervision and management layers, raising costs.

Distance Between Senior Staff and Shop Floor Workers

  • Worsened relations between workers and managers.

  • Lack of understanding may result in demotivation and conflicts.