3.3.3 Economies and Diseconomies of Scale

Economies of scale = A reduction in LRAC

Internal economies of scale: happens within a business

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In turn they all act the same as they all increase TC but QD is rising much faster which decrease AC

R - Risk bearing - They can spread risk which is an opportunity cost over a larger output range which will lower AC

F - Financial - Negotiate lower rates of IR when they get loans from banks as they become more reputable - Costs can be spread over a larger range of output

M - Managerial - As firms increase in size they can hire specialist managers - monitor productivity of workforce and boost them - and bring specialist skills which will in turn boost productivity of the business - productivity will be increasing faster than costs

T - Technical - Bring in specialist machinery to boost productivity, firms are using their factors more efficiently , employing more workers and making them specialised. So, costs are gonna rise but productivity will rise more

M - Marketing - As they grow larger they can bulk buy advertising which will spread their advertising costs over a range out output to increase return

P - Purchasing - Bulk buying - lots of raw materials - negotiating discounts - i.e. 2 for 1

External economies of scale: happens outside of a business

• Better transport infrastructure

• Component suppliers move closer

• R&D firms move closer

All of these reduce LRAC of a firm in comparison to internal economies of scale which increase TC

Diseconomies of scale

This occurs when LRAC increase faster as output increases

Control - As businesses become larger it makes it harder for managers to keep them under control which may have a negative impact of the productivity of workers - which will mean TC rises faster than Quantity

Communication - Managers to workers or workers to manager i.e. if workers have better ideas to improve efficiency but it takes too long to get to the top. This time lag will have a negative effect on productivity

Coordination - It may be hard for different departments to run along side each other i.e, HR and marketing its hard for them to work together for the same end goal which will have an effect on productivuty

Motivation - As a firm gets bigger each individual worker may feel less values and in turn decrease morale which may lead to less productive workers - if they feel dispensible if they feel undervalued - therefore costs rises faster than output pushing up total costs

The Importances of Economies of Scale

1. Definition and Significance

• Economies of Scale refer to the cost advantages that businesses experience as they increase their production scale. This results in lower unit costs as production expands over time. For example, doubling inputs can lead to more than double the output due to increased efficiency. 1

2. Benefits of Economies of Scale

• Achieving economies of scale allows businesses to use fewer inputs per unit of output, leading to increased productive efficiency. This can result in lower prices for consumers and higher profits for shareholders. For instance, large retailers like Amazon benefit significantly from economies of scale. 2

3. Cost Curves and Efficiency

• The average cost curve typically falls as businesses achieve internal economies of scale. The lowest point on this curve indicates the minimum efficient scale, where productive efficiency is maximized. If production increases beyond this point, firms may experience dis economies of scale, leading to rising average costs. 3 ( related to diagram at bottom )

4. Profit Maximization

• A profit-maximizing firm produces where marginal cost meets marginal revenue. As firms grow and reduce their average costs, they can lower prices while increasing total profits. For example, a firm may reduce its price from P1 to P2 while increasing output, leading to higher overall profits despite lower per-unit prices. 4 ( related to disgaram at the bittom )

5. Microeconomic Implications

• Economies of scale contribute to economic efficiency, allowing businesses to operate closer to their productive efficiency. Large firms, such as supermarkets, benefit from bulk purchasing and vertical integration, which reduces costs and enables them to compete effectively against smaller retailers. As producer suprlus increases also they can then offer lower prices 5

6. Consumer Welfare

• Lower unit costs from economies of scale can translate into reduced prices for consumers, improving their welfare. This is because consumers are paying less for goods than they are willing to and therefore maximising utility For instance, low-cost airlines leverage economies of scale to offer affordable ticket prices, benefiting consumers significantly. 6

7. Potential Risks

• While economies of scale can enhance efficiency and consumer welfare, they may also lead to market failures. Large firms may engage in monopolistic behaviors, potentially harming consumer surplus through higher prices or lower quality products. 7

8. Macroeconomic Effects

• On a macro level, economies of scale can enhance a country's competitiveness in global markets. Large firms in industries like pharmaceuticals can leverage scale to boost exports and contribute to national economic growth. 8

Conclusion Understanding economies of scale is crucial for analyzing business efficiency, consumer welfare, and market dynamics. They play a significant role in shaping competitive landscapes and economic growth.