Economies of scale

• Definition of economies of scale: economies of scale arise when unit costs fall as output increases
• average cost per unit= total production costs in period (£) / total output in period (units)
• Definition of internal economies of scale: arise from increased output of the business itself, two types - internal + external
• 4 types of internal scale of economies :

  • purchasing economies
  • technical economies
  • managerial economies
  • financial economies
• Definition of purchasing economies: buying in greater quantities usually results in lower prices
• Definition of technical economies: the use of specialist equipment/processes to boost productivity.
• Definition of managerial economies: specialist managers can be employed to help reduce unit costs + boost efficiency
• Definition of financial economies: larger firms benefit from access to more + cheaper finance, allowing them to invest in new technology or expand into new market
• Definition of external economies of scale: arise from the industry as a whole e.g all competitors benefit
• 3 types of external economies of scale:

  • financial services
  • educational
  • supplier
• External economies of scale (financial services): financial services can improve, with banks and other finanical institutions providing services that may be particularly geared towards a particular industry e.g an industry where cash flow maybe a particular problem, debt factoring services may be made available at competitive rates.
• External economies of scale (educational): local colleges will set up training schemes suited to the largest employers needs, giving an available pool of skilled labour, reducing training costs for the firm
• External economies of scale (supplier): a network of suppliers may be attracted to an area where a particular industry is growing, setting up of local suppliers, often in competition with one another, reduces buying costs
• Definition of diseconomies of scale: lead to a rise in unit costs, they happen when a business expands beyond optimum size and average costs begin to increase, two types - internal + external
• Definition of internal diseconomies of scale: as an organisation grows and levels of hierarchy increases, the efficiency and effectiveness of communication breaks down.
• Reasons for internal diseconomies of scale:

  • coordination- the larger an organisation becomes the more difficult it is to coordinate.
  • motivation issues- with larger businesses it is harder to satisfy and motivate workers as many may feel that their views are ignored as they are distanced from the organisations decision makers
• Reasons for external diseconomies of scale:

  • overcrowding in industrial areas- traffic congestion may occur, resulting in late deliveries and staff arriving late for work.
  • increased prices of resources- more businesses in an area means increased demand for labour to work in that industry and the best employees may be harder to recruit and keep, land services + materials may all become more expensive as the industry grows. e.g rent
• Small firms cannot benefit from economies of scale, so how do they compete/survive? :

  • niche markets-> customer loyalty
  • provide personal services -> meet specific needs of customers e.g tailor made products/services
  • profit satisfaction rather than profit maximisation