What is economies of scale?

• Economies of scale are the cost advantages that a

business obtains due to expansion. When
economists are talking about economies of scale,
they are usually talking about internal economies
of scale. These are the advantages gained by an
individual firm by increasing its size i.e having
larger or more plants.
 What is diseconomies of scale?
• Diseconomies of scale are the disadvantages
of being too large. A firm that increases its
scale of operation to a point where it
encounters rising long run average costs is
said to be experiencing internal diseconomies
of scale.
 Internal and External economies of
scale.

• Internal economies of scale :- lower long run

average costs resulting from a firm growing in
size.
• External economies of scale :- lower long run
average costs resulting from an industry
growing in size.
Internal and external diseconomies of
scale.
• Internal diseconomies of scale :-higher long
run average cost arising from a firm growing
too large.
• External diseconomies of scale:- higher long
run average costs resulting from an industry
growing too large
 Types of Internal economies of scale.

• Buying economies
• Selling economies
• Managerial economies
• Financial economies
• Technical economies
• Research and development economies
• Risk-bearing economies.
 Buying Economies.
• These are the best known type. Large firms
that buy raw materials in bulk and place large
orders for capital equipment usually receive a
discount. This means that they have paid less
for each item purchased. They may receive a
better treatment because the suppliers will be
anxious to keep such large customers.
 Selling Economies.
• Every part of marketing has a cost – particularly
promotional methods such as advertising and
running a sales force. Many of these marketing
costs are fixed costs and so as a business gets
larger, it is able to spread the cost of marketing
over a wider range of products and sales – cutting
the average marketing cost per unit.
 Managerial Economies.
• As a firm grows, there is
greater potential for managers
to specialize in particular tasks
(e.g. marketing, human
resource management,
finance). Specialist managers
are likely to be more efficient
as they possess a high level of
expertise, experience and
qualifications compared to one
person in a smaller firm trying
to perform all of these roles.
 Financial economies
• Many small businesses find it
hard to obtain finance and
when they do obtain it, the
cost of the finance is often
quite high. This is because
small businesses are
perceived as being riskier
than larger businesses that
have developed a good track
record. Larger firms therefore
find it easier to find potential
lenders and to raise money at
lower interest rates.
 Technical Economies.
• Businesses with large-scale production can
use more advanced machinery (or use existing
machinery more efficiently). This may include
using mass production techniques, which are
a more efficient form of production. A larger
firm can also afford to invest more in research
and development.
 Research and development
economies.
• A large firm can have a research and
development department, since running such
a department can reduce average costs by
developing more efficient methods of
production and raise total revenue by
developing new products.
 Risk-bearing economies.
• Larger firms produce a range of products. This
enables them to spread the risks of trading. If
the profitability of one of the products it
produces falls, it can shift its resources to the
production of more profitable products.
 Internal Diseconomies of scale.
• Growing beyond a certain output can cause a
firms average costs to rise. This is because the
firm may encounter a number of problems
including difficulties :-
• controlling the firm.
• communication problems.
• poor industrial relations.
 Difficulty controlling the firm.
 It can be hard for those
managing a large firm to
supervise everything that is
happening in the business.
Management becomes more
complex and meetings are
necessary quite often.
This can increase administrative
costs and make the firm slower in
responding to changes in
marketing conditions.
 Communication problems.
• Difficult to ensure that everyone is aware
about their duties in a large firm and available
opportunities like training etc.
• The may not get a chance to exchange their
views and innovative ideas to the
management team.
 Poor industrial relations.
• Higher risk for larger firms as there will be
more conflicts and diverse opinions.
• Lack of motivation of workers, strikes will be
seen at certain situations in larger firms due to
poor industrial relations.
 External economies of scale.
• A skilled labour workforce – A
firm can recruit workers who
have been trained by other
firms in the industry.
• A good reputation – An area
can gain a reputation for high
quality production.
• Specialist suppliers of raw
materials and capital goods –
When an industry becomes
large enough, it can become
worthwhile for other industries,
called subsidiary industries to
set up for providing for the
needs of the industry.
 External economies of scale.
• Specialist services – Universities and
colleges ma run courses for workers in
large industries and banks and
transport firms may provide services,
specially designed to meet the
particular needs of firms in the
industry.
• Specialist markets – Some large
industries have specialist selling
places and arrangements such as corn
exchanges and insurance markets.
• Improved infrastructure – The growth
of an industry may encourage a govt
and private sector firms to provide
better road links, electricity supplies,
build new airports and develop dock
facilities.
 External Diseconomies of scale.
• Just as a firm can grow
too large, so can an
industry.
• Larger firms ->
transportation increase ->
congestion -> increased
journey time -> high
transport cost -> reduced
workers productivity.
• Growth of industry may
increase competition for
resources, pushing up the
price of key sites, capital
equipment and labour.