Economies and Diseconomies of Scale

Economies of Scale
1. ECONOMIES OF SCALE= where an increase in the scale of production leads to reductions in average total costs (ATC) for firms
  1. They are the cost advantages that a business can exploit by expanding their scale of production
  2. They give a business a competitive advantage in the market, leading to lower prices and/or higher profits
2. Internal Economies of Scale
  1. (Arise from the growth of the firm itself)
  2. Examples
    1. Technical Economies of Scale
      1. Specialisation
        Occurs by splitting complex production processes into separate tasks to boost productivity
        e.g. division of labour in mass production of cars
      2. The law of increased dimentions
        linked with the cubic law where doubling the height and width of a tanker or building leads to a more than proportionate increase in the cubic capacity
        e.g. important in distribution and transport industries as well as in travel and leisure
      3. Investing in machinery
        large-scale businesses can afford to invest in expensive, specialist capital machinery
        e.g. a national newspaper can invest in large-scale printing presses that increase productivirt and reduce unit costs. It wouldn't be viable or cost-efficient for the producers of a church newsletter to buy this technology
    2. Marketing Economies of Scale
      1. large firms can spread their advertising and marketing budget over a large output
    3. Managerial Economies of Scale
      1. a form of the division of labour; large firms can justify having specialist senior managers in particular disciplines such as company law and intellectual property.
        Better management and investment in human resources raises productivity and thus reduces unit cost
    4. Financial Economies of Scale
      1. larger firms are rated by banks as 'credit worthy' sp are given access to credit facilities with more favourable rates of borrowing. Conversely, smaller firms often face higher rates of interest on their overdrafts and loans, being judged more 'risky'.
        Businesses on the stock market can normally raise extra financial capital more cheaply through the issue of shares.
        If the firm has strong buying power it can purchase its raw materials in bulk at negotiated discounted prices
      2. e.g. the ability of electricity generators to secure lower prices when negotiatong coal and gas supply contracts
      3. e.g. major supermarkets having significant power when purchasing supplies from farmers and wine growers
    5. Network Economies of Scale
      1. the extra cost of adding one more user to a network is close to nothing but the resulting benefits may be huge because each new user to the network can then interact and trade with all of the existing members or parts of the network
        as networks and services are more widely used if they become more valuable to the business that provides them
      2. e.g. the rapid expansion of e-commerce
      3. can be found in areas such as online auctions and air transport networks
3. External Economies of Scale
  1. (Occur outside of a firm but within an industry)
  2. When an industry's scope of operations expand, external economies of scale are achieved
    1. e.g. this might happen due to the creation of a better transportation network that might led to cost reductions for a company working within that industry
    2. e.g. the development of research and development facilities in universities that several local businesses can benefit from lead to external economies of scale
    3. e.g. the relocation of component suppliers and other support businesses close to the main centre of manufacturing can also lead to an external cost saving. As has been done in the Sunderland Nissan Car Factory, inside the same building, smaller businesses supplying different parts for the car can rent out the space and mean Nissan don't have to pay for long traveling costs
Diseconomies of Scale
1. DISECONOMIES OF SCALE= where an increase in the scale of production leads to an increase in the average total costs (ATC) for firms
2. Can arise from a lack of...
  1. CONTROL
    1. Control monitoring productivity and quality of output from thousands of employees in big corporations is difficult and costly
  2. COORDINATION
    1. Can be difficult to coordinate complicated production processes across several plants in different locations and different countries. Achieving efficient flows of information in large firms is expensive, as is the cost of managing supply contracts with hundreds of different suppliers at different points in an industry's supply chain
  3. COOPERATION
    1. Workers in large firms may feel a sense of alienation subsequently causing a lack of motivation
    2. Productivity of labour may fall if people don't feel an integral part of the business leading to wastage of factor inputs and higher costs
3. Avoiding diseconomies of scale...
  1. developments in human resource management (increases cooperation), a human resources manager can improve recruitment procedures, training, promotion, retention and support of workers
  2. performance-related pay schemes (provide incentives)
  3. Out-source (transfer portions of work) to specialist firms (outside suppliers) overcomes problems of control and coordination
Competition and Monopolies
1. COMPETITION= a market situation in which there are a large number of buyers and sellers
2. MONOPOLY= a market structure dominated by a single seller of a good
3. A high level of competition is necessary for markets to function well. An extremely competitive market situation is called 'perfect competition'.
4. Advantages of competitive markets...
  1. lead to productive efficiency, with goods produced at minimum possible cost per unit
  2. Firms will produce what the consumer want, so there will be consumer sovereignty, or they wont survive in the market
  3. Firms will have to charge a price just a little about the cost of production
5. Reasons why we might not expect many markets in developed economies to be highly competitive...
  1. The larger a firm becomes, the lower the cost of producing a unit of output is. In many industries there are considerable economies of scale to exploit, so firms have to be large to benefit fully. This may mean there is only room for a few firms or even just one, a monopoly, to exist.
  2. The profit motive motivates firms to compete away other firms in the market, legally or otherwise
    1. profits made from being able to exploit economies of scale could be invested in research and development to make new products that consumers prefer to those of rival firms, further eliminating competition
The average cost curve illustrating economies and diseconomies of scale
2. Q1 to Q2 is where there are economies of scale
  1. Q2 is when a firm is productively efficient
    1. Q2 to Q3 is where there are diseconomies of scale
3. As output increases firms are getting larger

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economies_and_diseconomies_of_scale-_the_average_cost_curve (image/jpg)

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Economies and Diseconomies of Scale

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