3.3 - Economies and Diseconomies of scale Flashcards
revenues, costs and profits
When do internal economies of scale occur?
When a firms gets larger
When do external economies of scale occur?
When an industry gets larger
What are economies of scale?
The benefits a firm receives from increasing its scale of output in the long-run that will initially decrease the firm’s long-run average total costs.
> firms enjoys increasing returns to scale
What are increasing returns to scale?
Occurs when an increase in inputs leads to a larger than proportional increase in output
What are diseconomies of scale?
Reasons that cause a firm’s long run average costs to increase after a certain level of increased output
> firms face decreasing returns to scale during these times
What are decreasing returns to scale?
Occurs when an increase the quantity of input leads to a less than proportional increase in the quantity of output
What are internal economies of scale
- Internal economies of scale refer to the cost advantages that a single firm can achieve as it grows in size and expands its production capacity.
- These cost savings are typically a result of factors under the firm’s direct control, such as improved production processes, specialisation of labour, and better management practices.
- Internal economies of scale are specific to the individual firm and are a result of its internal operations and decisions.
What are external economies of scale?
- External economies of scale refer to the cost advantages that multiple firms in the same industry or region can collectively enjoy as the industry or region grows.
- These cost savings are typically a result of factors beyond the control of any single firm, such as the availability of a skilled labour force, specialised suppliers, infrastructure development, or a supportive business environment.
- External economies of scale benefit all firms in a particular industry or location, and individual firms do not have direct control over them.
What are the economies of scale?
- Financial economies
- Managerial economies
- Marketing economies
- Purchasing economies
- Technical economies
- Risk-bearing economies
What are financial economies?
Larger firms may have access to more favourable financing options, including lower interest rates on loans and better terms from suppliers due to their size and financial stability. This lowers their average costs.
(perceived as less risky)
What are purchasing economies of scale?
Larger firms are more able to buy raw material (+other supplies) in greater volumes and recieve bulk purchase discounts which lower average costs.
What are managerial economies?
Larger firms may benefit from being able to employ specialised management teams meaning they are likely to have better coordination, and more efficient decision-making processes. This can result in cost savings and increased efficiency.
> managers in small firms often have to fulfil multiple roles and are less specialised.
What are marketing economies?
Larger firms can divide their marketing budgets across larger outputs, so
the average cost of advertising per unit is less than that of a smaller firm.
This lowers their average costs
What are technical economies?
Larger firms can afford to invest in more advanced and productive
machinery and capital (at a higher level of capacity - due to their increased output) , which will lower their average costs.
What are risk-bearing economies?
- Larger firms are able to spread the risk of failure by increasing its number of products (greater product diversification)
- They are therefore better equipped to handle unexpected market fluctuations and risks, reducing the overall cost of risk management/ failure
What are the diseconomies of scale?
- Management diseconomies
- Communication diseconomies
- Geographical diseconomies
- Cultural diseconomies
What are management diseconomies?
- management structure can become overly complex and less efficient
- often managers work in their self interest rather than in the interest of the firm
> reduces efficiency and increases average costs
What are communication diseconomies?
- With an increase in size, communication becomes more challenging, leading to misunderstandings and errors that can increase average costs
What are geographical diseconomies?
- occurs when a firm has widespread bases of operations & this leads to logistical & communication challenges which can raise average costs
What are cultural diseconomies?
Occur when a firm expands into foreign markets in which workers have different cultural work/productivity norms which can raise average costs
What is worker alienation?
In very large organizations, employees may feel disconnected from the company’s goals and values, which can result in lower productivity and higher turnover rates.
What is the minimum efficiency scale?
- the level of production at which a firm achieves the lowest possible long-run average cost per unit of output.
>the point at which economies of scale are fully realised, and any further increase in production would result in diseconomies of scale.
Why should firms operate at minimum efficiency scale?
- When a firm operates at or near its MES, it can produce goods or services at the lowest cost,
- making it highly competitive in the market.
- MES can vary from one industry to another and depends on factors such as technology, market demand, and the specific production process.
Why might firms that operate below their minimum efficiency scale be out-competed?
- Firms that operate below their MES may not be able to compete effectively due to higher production costs (not exploiting economies of scale)
- while those operating above it may experience inefficiencies and increased costs. (diseconomies of scale)
