3.3.3 Economies and diseconomies of scale

Question 1

Economies of scale

Answer 1

The cost advantages of production on a large scale.

Question 2

What are the types of economies of scale?

Answer 2

• Internal
• External

Question 3

Internal economies of scale

Answer 3

Internal economies of scale involve changes within a firm.

Question 4

External economies of scale

Answer 4

Internal economies of scale involve changes outside a firm.

Question 5

Examples of external economies of scale

Answer 5

• Local colleges may start to offer qualifications needed by big local employers, reducing the firms’ training costs.
• Large companies locating in an area may lead to improvements in road networks or local public transport.
• If lots of firms doing similar or related things locate near each other, they may be able to share resources (e.g. research facilities). Suppliers may also decide to locate in the same area, reducing transport costs.

Question 6

Economies of scale and fixed costs

Answer 6

There are huge economies of scale in industries with high fixed costs but low variable costs. In some cases, the structure of whole industries can change to take advantage of this.

As a firm grows by taking advantage of its large economies of scale, other firms in the industry may be forced to follow the same strategy, or shut down. The result is an industry dominated by a few large firms (or a single firm).

Question 7

How might economies of scale lead to monopoly power?

Answer 7

As a firm’s average cost for making a product falls, it can sell that product at a lower price, undercutting its competition.

This can lead to a firm gaining a bigger and bigger market share, as it continually offers products at prices that are lower than the competition.

In this way, a firm can eventually force its competitors out of business and become the only supplier of the product – i.e. it will have a monopoly.

Question 8

Why might a firm getting bigger be bad for a firm?

Answer 8

As a firm increases in size, it can encounter diseconomies of scale.

Question 9

Diseconomies of scale

Answer 9

The cost disadvantages of production on a large scale.

They cause average costs to rise as output rises.

They can be internal or external.

Question 10

Examples of external diseconomies of scale

Answer 10

• As a whole industry becomes bigger, the price of raw materials may increase (since demand will be greater).
• Buying large amounts of materials may not make them less expensive per unit. If local supplies aren’t sufficient, more expensive goods from further afield may have to be bought.

Question 11

Examples of internal diseconomies of scale

Answer 11

• Wastage and loss can increase, as materials might seem in plentiful supply. Bigger warehouses might lead to more things getting lost or mislaid.
• Communication may become more difficult as a firm grows, affecting staff morale.
• Managers may be less able to control what goes on.
• It becomes more difficult to coordinate activities between different divisions and departments.