Economies of Scale

What is Economies of Scale?

Economies of scale occur when the cost of producing a unit (the unit cost) falls as the firms output increases.

What does that mean?

The unit cost is the average cost of one unit. Economies of Scale occur when the cost per unit falls as output expands. Diseconomies of Scale occur when the cost per unit increases as output expands.

What are the causes of EOS or DEOS?

Economies of Scale (saving in costs) are: Technical (better machinery) Buying (Bulk) Financial (Less interest on borrowed money) Marketing (spread cost) Managerial (spread roles) Distribution (Bulk delivery) Diseconomies of Scale are: When the company becomes to big to run it efficiently

Types of Internal Economies

Distribution - If one lorry can carry 8Xs as much as another but only costs twice as much then the extra cost can be offset by the fact that it can carry an extra load. Purchasing - bulk buying - as a business buys more from its suppliers, it may be possible to negotiate a bulk purchase discount.

 Technological - if a business buys new machinery which is of a higher technical specification, this ought to bring benefits in the form of increased efficiency. Marketing - companies become more proficient at launching new products as their experience grows. When a company such as Heinz advertises a new product it is also advertising the brand, therefore advertising costs per product fall.

 Financial - A larger company is usually a safer company and so the bank will charge them a lower rate of interest on loans. Managerial - As a business grows it is able to employ specialists to run individual functions rather than a few people having a range of functions.

 Risk-bearing - a larger business may be able to diversify into different markets which are not related to its core business.This may reduce risk as it is now in two unrelated markets.

Specialisation - a large business may be able to employ individuals to specialise in specific tasks which they will become experts in, and therefore more efficient.

Diseconomies of Scale
As output increase so do unit costs Overtime needs to be paid Increased maintenance costs Supplier may charge a higher price if it is faced with either of above problems Poor communication Loss of control of the business

A Maths Moment
To calculate the average cost (or unit cost) use the following equation:
Unit cost = total cost output

For example, if total costs are 200 000 and the output is 5000 units, the unit cost will be 40 Lets check that.

Activity 1
If the output rose to 10 000 units whilst total costs increased to 380 000, what is the new average or unit cost? Do you think this firm is benefiting from economies of scale?

Review
Therefore, economies of scale is when a large firm can produce at lower average cost than smaller firms. They can pass on these economies of scale to consumers as lower prices. This will help them increase their sales, their ,market share and their profits