Economies of Scale

A graph of average costs vs Output, showing costs fall at first, then stay flat, then rist again

EOS - Economies of scale
MES - Minimum efficient scale
DOS - Diseconomies of scale

Internal Economies of Scale

Internal economies of scale are experienced when a firm becomes larger. They cause the average cost of production to fall as output increases.

Purchasing

Purchasing economies of scale mean that a firm is able to by in bulk, and therefore the average cost per unit is smaller.

Technical

E.g self-checkouts. Larger firms can invest in more technologies that reduces their costs.

Managerial

Using specialised staff who are better at the job. They are able to divide labour more and have more experience in their positions, since they can do a single job more efficiently than having to do multiple, since there is more of that job to be done in a large firm.

Risk-bearing

They are able to expand into new areas and bear the costs if they fail, so they are more likely to take risks, which may result in bigger profits, while having little actual risk to them.

Financial

Large firms are able to get lower interest rates on loans, since they can borrow bigger amounts and are more reliable than smaller firms.

Marketing

Large firms can divide their marketing budgets across larger outputs, so the average cost of advertising per unit is less than a smaller firm's.

External Economies of Scale

External economies of scale occur outside a firm but within an industry.

  • Transport networks / infrastructure
  • Suppliers relocate closer to firms, decreasing costs
  • Influx of human capital / skilled workers.

An example of this is silicon valley.

External economies of scale involve changes outside of the business, such as the expansion of the industry which the firm is a part of. They lower unit costs for many/all firms.

Diseconomies of Scale

When firms get too big, costs can increase - They are no longer in the efficient section of the graph.

Control

Harder to control standards and how the business is run at a low level. You cannot visit every store of Starbucks by yourself regularly.

Communication

Harder to communicate messages in the firm as there are far more people to communicate the message to.

Alienation of workers

When workers are working in a large corporation they can feel alienated as they as an individual are not important to the business. It can cause a loss of morale and decrease productivity.

Internal Politics

Shareholders may have differing opinions on what should be done vs CEO and managers.

Judgements

The extent to which a firm will experience diseconomies of scale depends on how fast the firm grows. A firm growing too fast could mean the firm does not have time to develop systems and processes in order to manage the diseconomies of scale.