Economies and Diseconomies of Scale

Economies of Scale

• This is achieved when LRAC is falling as output increases
• firms can enjoy the benefits that come from exploiting EOS
• There are 2 types:
  • Internal
  • this is what occurs when an individual firm experiences EOS
  • External
  • this is what occurs when all firms in the same industry occur and they are all able to exploit EOS

Internal EOS

• what occurs within a firm where output is increasing whilst LRAC is decreasing
• productivity will rise much faster than total costs, which is why AC are falling
• 6 different types:
  • important in markets where technology is a key part of the business
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  • Risk Bearing
    • usually happens when a firm has a diverse product range as they spread the cost of uncertainty in doing so
    • if one part is not successful they have other parts to rely on
  • Financial
    • the larger the firm is, banks are more willing to lend to them at lower interest rates as they are more trusted and confident in them bringing LRAC down
    • due to the lower perceived risk of lower interest rates as they are more confident that they will get their returns
    • the more output a firm produces the bigger it gets
    • also more likely to give them larger loans as they are more confident that they will get it back
  • Managerial
    • if a firm employs specialist managers can improve productivity of labor within these departments
    • can also make sure that those departments can run at the most efficient level and can be the most productive
    • improve productivity and labor
    • if one person tried to manage all departments they would find it difficult to do it efficiently
  • Technical
    • buying specialist machinery to do a more efficient job
    • produce more in a given time period
    • more efficient production
    • could also mean specialization of labor or divided, which increases productivity within a firm, reducing LRAC
      • productivity is where more can be produced in the same time period
    • may also benefit from the LAW OF INCREASED DIMENSIONS
      • if a firm increases its capacity and you get more returns
      • if a firm doubles its lorries but can take 3 times as many things
  • Marketing
    • the bigger the firm the more able a firm is to spread its marketing budget over a larger range of output → will lead to LRAC falling
    • if a firm wants to market on a large scale they will have the power to negotiate lower prices for its marketing
    • the size of the firm means that it will have some sort of buying power which will mean it can negotiate lower prices which will bring down LRAC
  • Purchasing
    • the bigger the firm the more likely it is to be successful in negotiating lower prices for goods and raw materials
    • could occur as they have the opportunity to bulk buy which makes it easier to negotiate low prices
    • the size and reputability of the firm means that suppliers are willing to trust and make links with the firms in hopes that they will return

External EOS

• when the industry grows in size → many firms cluster together → can benefit in many ways
• examples include
  • better transport infrastructure
  • new roads or railways like the Elizabethan line
  • reduces costs as a business as it will be cheaper to sell your goods if you need your transport there
  • also will make it cheaper to access raw materials and components
  • therefore, total costs will fall leading to the AC falling
  • component suppliers may move closer to you
  • as a huge firm it is of their interest to be closer
    • thus cutting down the cost of getting these raw materials transported to you
    • leads to TC decreasing
  • research and development firms may more closer
  • firms can use them to improve their technology which will reduce their cost as a result of using them
  • they can all reduce total costs which will lead to AC falling
  • all benefits of a large business

Diseconomies of Scale

• an increase in LRAC as output increases