Economics of scale

Highlights

What is Economics
What is Scale
Economics of Scale?
Types of Economies of Scale
Supply and Demand side EOS
Formula and Graph for EOS
Limitations
References
Economics of Scale

What is Economics
Economics is the study of how people
choose to use resources.
Resources include the :
1.Time and talent people have available,
2.The land, buildings, equipment, and other
tools on hand, and
3.The knowledge of how to combine them to
create useful products and services.
Economics of Scale

What is Scale
An ordered reference standard; "judging on
a scale of 1 to 10"
Pattern, make, regulate, set, measure, or
estimate according to some rate or standard
The proportion between two sets of
dimensions.

Economics of Scale

Economics of Scale
Economics of Scale exist when the production
cost of a single product decreases with the
number of unit produced
Refer to the situation in which the cost of
producing an additional unit of output (i.e., the
marginal cost) of a product (i.e., a good or
service) decreases as the volume of output (i.e.,
the scale of production) increases

Economics of Scale

Economics of Scale
It could also be defined as the situation in
which an equal percentage increase in all
inputs results in a greater percentage
increase in output.
Generally speaking, economies of scale is
about the benefits gained by the
production of large volume of a product
Economics of Scale

 In business, economies of scale are

usually considered in relation to specific
areas of the production process, which
may be technical, managerial, marketing,
finance, and risk.
In achieving economies of scale, many
factors must be considered.
The ability of larger entities (governments,
businesses) to produce things more cheaply per
unit because they produce so many

Economics of Scale

Type of EOS
External economies - the cost per
unit depends on the size of the
industry, not the size of firm
Internal economies - the cost per
unit depends on size of the
individual firm.
Economics of Scale

Internal
Internal economics of scale advantages
that arise as a result of the growth of the
firm

Technical
Commercial
Financial
Managerial
Risk Bearing
Economics of Scale

External
External economies of scale the
advantages firms can gain as a result of
the growth of the industry normally
associated with a particular area
Supply of skilled labour
Reputation
Local knowledge and skills
Infrastructure
Training facilities
Economics of Scale

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Internal: Technical
Specialisation large organisations
can employ specialised labour
Indivisibility of plant machines cant be
broken down to do smaller jobs!
Principle of multiples firms using more
than one machine of different capacities more efficient
Increased dimensions bigger containers
can reduce average cost
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Commercial
Large firms can negotiate favourable
prices as a result of buying in bulk
Large firms may have advantages in
keeping prices higher because of their
market power

Economics of Scale

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Financial
Large firms able to negotiate cheaper
finance deals
Large firms able to be more flexible
about finance share options, rights
issues, etc.
Large firms able to utilise skills of
merchant banks to arrange finance

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Managerial
Use of specialists accountants,
marketing, lawyers, production,
human resources, etc.

Economics of Scale

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Risk Bearing
Diversification
Markets across regions/countries
Product ranges
R&D

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Demand And Supply side EOS

Network effects cause the value of a
product to individual customers to
increase as more people own or use the
product.
They could be considered the demand
side counterpart of economies of scale,
which occur on the supply side (i.e.,
through larger volumes of output).

Economics of Scale

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Economics of Scale: Formula &Graph

The advantages of large scale production that
result in lower unit (average) costs (cost per
unit)
AC = TC / Q
Economies of scale spreads total costs over a
greater range of output
Marginal costs lower than average costs, so
that producing more makes average costs lower
Economics of Scale

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Economies of Scale
Capital

Land

Labour

Output

Scale A

100

Scale B

10

300

TC

AC

Assume each unit of capital = Rs.5, Land = Rs.8

and Labour = Rs.2
Calculate TC and then AC for the two different
scales (sizes) of production facility
What happens and why?
Economics of Scale

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Economies of Scale
Capital

Land

Labour

Output

TC

AC

Scale A

100

57

0.57

Scale B

10

300

164

0.54

PER UNIT has fallen

Dont get confused between Total Cost and Average Cost
Overall costs will rise but unit costs can fall
Why?

Economics of Scale

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Economies of Scale
Unit Cost

LRAC: Long run average

cost
Scale A

57p
Scale B
54p
LRAC

MES
Economics of Scale

Output
20

Limitation
Problems of management
Maintaining effective communication
Co-ordinating activities often across
the globe!
De-motivation and alienation of staff
Divorce of ownership and control

Economics of Scale

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Economics of Scale

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 Minimum Efficient Scale (MES) the point

at which the increase in the scale of production
yields no significant unit cost benefits
Minimum Efficient Plant Size the point where
increasing the scale of production of an individual
plant within the industry yields no significant unit
cost benefits

Economics of Scale

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widget
in general, widget (pronounced WIH-jit) is a term used to
refer to any discrete object, usually of some mechanical
nature and relatively small size, when it doesn't have a
name, when you can't remember the name, or when you're
talking about a class of certain unknown objects in general.
(According to Eric Raymond, "legend has it that the
original widgets were holders for buggy whips," but this
was possibly written tongue-in-cheek.)
In computers, a widget is an element of a graphical user
interface (GUI) that displays information or provides a
specific way for a user to interact with the operating
system and application. Widgets include icons, pull-down
menus, buttons, selection boxes, progress indicators, on-off
checkmarks, scroll bars, windows, window edges (that let
you resize the window), toggle buttons, forms, and many
other devices for displaying information and for inviting,
accepting, and responding to user actions.
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{Economic of scale
Economies of Scale make it advantageous for
each country to specialize in the production of
only limited number of goods & services and to
manufacture them in large quantities, partly
for exports.
Two types:
(1)External economiescost per unit depends on the size of industry,
not the size of the firm.
(2) Internal economiescost per unit depends on the size of the
individual firm
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Example
If a company makes 500 widgets, they
cost the company 10 cents a piece to
produce. Another company makes
100,000 widgets, and can therefore
purchase the materials necessary to
make them for much cheaper than its
competitors, so each widget only costs
this company 5 cents a piece to
produce.
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Economy of scale embraces

three elements
1. Size of the firm
2. Size of Manufacturing Plant

3. Size of Machine

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 More and more companies try to utilize the

advantages of other countries in the whole
world to enlarge their business scale and as
a result reduce the cost of their products and
services.

Factors:
a) Enablers
b) Inhibits
c) Paradigms
d) Timing
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