3.3.3 Economies and Diseconomies of Scale

Question 1

Economies of scale

Answer 1

Economies of scale are the advantages or large scale production that enable a large business to to produce at a lower average cost than a smaller business. Long run costs fall as output increases.

Question 2

Diseconomies of Scale

Answer 2

They are disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise. A rise in long run average costs of production as output rises.

Question 3

The minimum efficient scale

Answer 3

The minimum level of output needed for a business to fully exploit economies of scale. It is the point where the LRAC curve first levels out and when constant returns to scale is first met.

Question 4

Internal economies of Scale

Answer 4

An advantage that a firm is able to enjoy because of a growth in the firm, independent of external factors.
> Technical economies - larger firms can afford to invest in more advanced and productive machinery and capital, which will lower their average costs.
> Financial economies - large firms have greater security because they have more assets. This makes it easier for larger firms to obtain finance from banks and interest rates would be lower due to lower risk. Investment is more accessible.
> Risk-bearing economies - when a firm gets larger it can spread its production range. They can spread the cost of uncertainty. If one part is unsuccessful, their whole business will not collapse.
> Managerial economies - large companies can afford to appoint specialist managers who are able to do the job better. It can lower average costs because staff are an indivisibility (the total cost is the same no matter output).
> Marketing economies - larger firms can divide marketing budgets across larger outputs, so the average cost of advertising per unit is less than for a smaller firm.
> Purchasing economies - larger firms can bulk-buy, lowering unit costs. Distribution may also be cheaper.

Question 5

External economies of scale:

Answer 5

An advantage which arises from the growth of the industry within which the firm operates, independent to the firm itself.
> Labour - businesses in an area with other successful firms from the same industry will find that labour will come to that area if they want a job in that industry.
- Local education and training providers more likely to develop courses for jobs in those industries.
- Can hire staff trainee by other businesses in the industry.

Question 6

Diseconomies of Scale:

Answer 6

> Workers - in large businesses workers may think they are unnoticed and have less chance of promotion, making them demotivated and less productive.
Geography - a firm may have to transport goods huge distances then they may have higher average costs. Head office may also find it hard to control parts of the business long distances away.
Change - can be harder for a large firm to respond to change. Can also be slower at responding than a small company.
Management - as a business gets larger it will progressively get more difficult to coordinate and control all the different parts of the business. Can lead to poorer quality work and bad business decisions.
Communication will also be worse due to the number of people it must pass through and the distance.