Economies of Scale

Economies of Scale

 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
Economies of Scale

 Internal – advantages that arise as a result

of the growth of the firm
Technical
Commercial
Financial
Managerial
Risk Bearing
Economies of Scale
 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/ Brand name
 Local knowledge and skills
 Infrastructure
 Training facilities
Economies of Scale
Capital Land Labour Output TC AC

Scale A 5 3 4 100

Scale B 10 6 8 300

•Assume each unit of capital = £5, Land = £8

and Labour = £2
•Calculate TC and then AC for the two different
‘scales’ (‘sizes’) of production facility
•What happens and why?
Economies of Scale
Capital Land Labour Output TC AC

Scale A 5 3 4 100 57 0.57

Scale B 10 6 8 300 164 0.54

•Doubling the scale of production (a rise of 100%) has led

to an increase in output of 200% - therefore cost of
production
•PER UNIT has fallen
•Don’t get confused between Total Cost and Average Cost
•Overall ‘costs’ will rise but unit costs can fall
•Why?
Economies of Scale
 Internal: Technical
 Specialisation – large organisations can employ
specialised labour
 Indivisibility of plant – machines can’t be broken down to
do smaller jobs!
 Principle of multiples – firms using more than one
machine of different capacities - more efficient
Economies of Scale

 Indivisibility of Plant:
 Not viable to produce products like oil,
chemicals on small scale – need large
amounts of capital
 Agriculture – machinery appropriate for
large scale work – combines, etc.
Economies of Scale

 Principle of Multiples:
 Some production processes need more
than one machine
 Different capacities
 May need more than one machine to be
fully efficient
Economies of Scale
 Principle of Multiples: e.g.

Machine A Machine B Machine C Machine D

Capacity = 10 Capacity = 20 Capacity = 15 Capacity = 30

per hour per hour per hour per hour
Cost = £100 Cost = £50 per Cost = £150 Cost = £200
per machine machine per machine per machine

Company A = 1 of each machine, output per hour = 10

Total Cost = £500
AC = £50 per unit
Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60
Total Cost = £1750
AC = £29.16 per unit
Economies of Scale

 Commercial
 Large firms can negotiate favourable
prices as a result of buying in bulk
Economies of Scale
 Financial
 Large firms able to negotiate cheaper
finance deals
 Large firms able to be more flexible about
finance – share options, etc.
 Large firms able to utilise skills of
merchant banks to arrange finance
Economies of Scale

Managerial
Use of specialists – accountants,
marketing, lawyers, production,
human resources, etc.
Economies of Scale

Risk Bearing
Diversification
Markets across regions/countries
Product ranges
R&D
 Economies of Scale

Unit Cost

Scale A
82p

Scale B
54p

LRAC

MES Output
Diseconomies of Scale
 The disadvantages of large scale production
that can lead to increasing average costs
 Problems of management
 Maintaining effective communication
 Co-ordinating activities – often across the globe!
 De-motivation and alienation of staff
 Owners different from managers