Economies of scale

Economies of Scale

Definition

• Reductions in a firm’s average unit costs of production due to an increase in the scale of operations.

Importance

• Significant cost benefits can make it hard for smaller firms to compete in industries like oil refining and soft drink production.

Sources of Economies of Scale

1. Purchasing Economies

   • Discounts from suppliers for bulk orders due to lower processing costs.

2. Technical Economies

   • Access to advanced technology (e.g., flow production lines).

   • Higher capacity leads to lower unit costs.

3. Financial Economies

   • Favorable financing terms for large businesses.

   • Lower interest rates and cheaper public financing options.

4. Marketing Economies

   • Marketing costs do not increase at the same rate as sales, allowing for efficient cost spreading.

5. Managerial Economies

   • Ability to hire specialized managers can improve efficiency and reduce costs.

External Economies of Scale

• Tax Breaks: Government incentives reduce production costs for all firms in the industry.

• Economies of Concentration: Industry clustering enhances access to skilled labor and infrastructure.

Diseconomies of Scale

• Definition: Factors that cause average production costs to rise as scale increases.

• Causes:

  1. Communication Problems

     • Poor feedback, information distortion, and management inefficiency.

  2. Alienation of Workforce

     • Employee disengagement due to lack of direct involvement and repetitive tasks in large firms.

  3. Poor Coordination and Slow Decision-Making

     • Complexity in managing multiple departments or locations leads to sluggishness in operational decisions.