economies and diseconomies of scale

• What are economies of scale?

  As a firm grows, it is able to increase its scale of output, generating efficiencies that lower its average costs (AC) of production

  • These efficiencies are called economies of scale
• What are diseconomies of scale?

  • As a firm continues to increase its scale of output, it will reach a point where its average costs (AC) will start to increase
  • The reasons for the increase in average costs are called diseconomies of scale
• What do economies of scale help firms to generate?

  • Economies of scale are the reason that firms generate increasing returns to scale in the long run
• Analyse the LRAC diagram

  • With relatively low levels of output, the firms average costs are high
  • As the firm increases its output, it begins to benefit from economies of scale, which lower the average cost per unit
  • At some level of output, a firm will not be able to reduce costs any further; this point is called productive efficiency
  • Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale

  
• What are internal economies of scale?

  • Internal economies of scale occur as a result of the growth in the scale of production within the firm
• What are the types of the internal economies of scale?

  Richard's Mom Flew Past The Moon

  Risk taking

  managerial

  financial

  purchasing

  technical

  marketing
• What is financial economy of scale?

  • Large firms often receive lower interest rates on loans than smaller firms, as they are perceived as less risky (more likely to be able to repay the loan). A cheaper loan lowers the LRAC
• What is managerial economy of scale?

  • It occurs when large firms can employ specialist managers who are more efficient at certain tasks, and this efficiency lowers the LRAC. Managers in small firms often have to fulfil multiple roles and are less specialised
• What is marketing economy of scale?

  Large firms spread the cost of advertising over a large number of sales (units), and this reduces the LRAC. They can also reuse marketing materials in different geographic regions, which further lowers the LRAC
• What is purchasing economy of scale?

  • This occurs when large firms buy raw materials in greater volumes and receive a bulk purchase discount, which lowers the LRAC. Bulk allows for firms to negotiate for a lower price with suppliers
• What is technical economies of scale?

  • Occur as a firm is able to use its machinery at a higher level of capacity due to the increased output, thereby spreading the cost of the machinery over more units and lowering the LRAC
• What is risk bearing economies of scale?

  • It occurs when a firm is able to spread the risk of failure by increasing its numbers of products, i.e greater product diversification; less cost failure lowers LRAC
• What is external economies of scale?

  • External economies of scale occur when there is an increase in the size of the industry in which the firm operates
  • The firm is able to benefit from lower average costs (AC) generated by factors outside of the firm
• What are the sources of External Economies of Scale?

  geographical cluster

  transport links

  favourable legislation

  skilled labour
• What is a geographical cluster?

  • As an industry grows, ancillary (lower down the supply chain) firms move closer to major manufacturers to cut costs & generate more business. This lowers the LRAC e.g. car manufacturers in Sunderland rely on the service of over 2,500 ancillary firms
• What are transport links?

  • Improved transport links develop around growing industries in order to help get people to work & to improve transport logistics. This lowers the LRAC e.g. Bangalore is known as India's Silicon Valley, and transportation projects have been successful in transforming the movement of people & goods
• What is skilled labour?

  • An increase in skilled labour can lower the cost of skilled labour, thereby lowering the LRAC. The larger the geographic cluster, the larger the pool of skilled labour
• What is favourable legislation?

  • This often generates significant reductions in LRAC as governments support certain industries in order to achieve their wider objectives 
• What are diseconomies to scale?

  • As a firm continues to increase its scale of output in the long-run, at some point its long run average cost (LRAC) will start to increase
  • The reasons for the increase in the LRAC are called diseconomies of scale
  • During this period, the firm is facing decreasing returns to scale
• What are the causes of diseconomies to scale?

  alienation

  bureaucracy

  communication diseconomy of scale

  Management diseconomy of scale

  geographical diseconomy of scale

  cultural diseconomy of scale
• What is alienation?

  workers are isolated, feel like they are just a cog in the process, which demotivates them and reduces productivity, therefore increasing LRAC e.g large call centres in India
• What is bureaucracy?

  Bureaucracy is all the paperwork, managers, filing and secretaries that a firm has to pay for when it expands, increasing LRAC.
• What is communication diseconomy of scale?

  • Occur when a firm with multiple layers of management & perhaps in multiple geographic locations, struggle to communicate quickly & efficiently leading to slow responses & increased LRAC
• What is management diseconomy of scale?

  • Occur when managers work more in their own interest than in the interest of the firm, e.g managers become territorial and obstructive thus reducing efficiency and increasing the LRAC
• What is a geographical diseconomy of scale?

  • Occur when a firm has widespread bases of operations & this leads to logistical and communication challenges which can raise the LRAC
• What is a cultural diseconomy of scale?

  • Occur when a firm expands into foreign markets in which workers have very different cultural work/productivity norms which can raise the LRAC
• What is the minimum efficient scale?

  • The minimum efficient scale is the lowest cost point on a long-run average total cost (LRAC) curve
  • It represents the lowest possible cost per unit that a firm in the industry can achieve in the long run
• how does a firm operate in the short run and long run?

  • In the short-run, the firm operates on its short-run average cost curve
  • In the long-run, the firm will increase its capacity (e.g. build a new factory), and then operate for a period of time on a new short-run cost curve
  • Each subsequent short-run average cost (SRAC) curve represents growth and an increase in size
  • Output increases with each period of growth
• what does this diagram show about how economies of scale occur along a LRAC curve?

  • Initially, firms experience increasing returns to scale as a result of the economies of scale
  • At a certain level of output, the firm will reach the minimum efficient scale where it experiences constant returns to scale
  • If it continues to grow beyond that level of output, the firm will experience decreasing returns to scale as diseconomies of scale occur