Economies of Scale

• What is economies of scale?

  occur when increasing output leads to lower long-run average costs. It means that as firms increase in size, they become more efficient.
• Economies of scale diagram

  Increasing output from Q1 to Q2, we see a decrease in long-run average costs from P1 to P2.

  Economies of scale are important because they mean that as firms increase in size, they can become more efficient. For certain industries, with significant economies of scale, e.g aeroplane manufacture, it is important to be a large firm; otherwise they will be inefficient.

  A) LRAC

  
• Diseconomies of Scale


  occur when long-run average costs start to rise with increased output.
• Diseconomies of Scale diagram

  Economies of scale occur up to Q1. After output Q1, long-run average costs start to rise.

  
• Reasons for Diseconomies of Scale

  1. Poor communication in a large firm. It can be hard to communicate ideas and new working practices.
  2. Alienation: Working in a highly specialized assembly line can be very boring if workers become de-motivated. In a large firm, there is an increased gap between top and bottom e.g. call centres
  3. Lack of control: when there is a large number of workers it is easier to escape with not working very hard because it is more difficult for managers to notice shirking.
• Overcoming Diseconomies of scale

  Firms may attempt to overcome diseconomies of scale by splitting up the firm into more manageable sections. For example, a large multinational may be split up into local geographical areas, with local managers facing incentives to maximise efficiency.
• Minimum Efficient Scale - What is it?

  the minimum point of output necessary to achieve the lowest A.C. on the LRAC
• Minimum Efficient Scale on the diagram

  the MEC is at Q1.

  • This has implications for the optimal number of firms in the industry
  • In a natural monopoly the optimal number of firms is one, therefore the MES would be equal to the total industry demand. E.g. Water or Electricity networks

  A) Minimum Efficient Scale

  B) LRAC

  
• What determines the minimum Efficient Scale

  • Degree of fixed costs
  • Scope for specialisation
• Returns to scale


  relates to how a firms production is affected by increasing all the inputs.
• Decreasing returns to scale

  occurs when an increase in all inputs (labour/capital) leads to a less than proportional increase in output.
• Decreasing returns to scale relationship with economies of scale

  If a firm faces constant input costs, then decreasing returns to scale imply rising long run average costs and diseconomies of scale.
• Internal Economies of Scale

  • Technical: large-scale machines or production processes that increase productivity
  • Purchasing: discounts on cost due to purchasing in bulk
  • Managerial: employing specialists to oversee and improve different parts of the production process
  • Risk-Bearing: spreading risks out across multiple investors
  • Financial: higher creditworthiness, which increases access to capital and more favorable interest rates
  • Marketing: more advertising power spread out across a larger market, as well as a position in the market to negotiate
• External Economies of scale

  occur outside of an individual company but within the same industry. eg. infrastructure