3.3.3 Economies and diseconomies of scale (main) Flashcards
Economies of scale
Economies of scale occur when increasing output leads to lower long-run average costs , i.e average costs fall over a range of output.
What are the 2 main types of economies of scale?
- Internal
- External
Internal economies of scale
Internal economies of scale are cost advantages a firm gains by increasing its production output, stemming from internal factors like improved production processes, specialization of labor, and better management practices, all within the firm’s contro
External economies of scale
External economies of scale refer to cost advantages that a firm can receive due to external factors, rather than factors internal to the firm
Examples of external economies of scale
- 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.
- Agglomeration economies: firms locating geographically to a place means that production is cheaper.
- 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.
Examples of internal economies of scale
- Technical economies of scale.
- Purchasing economies of e.g, bulk buying
- Managerial economies e.g. employing specialised staff to raise efficiency.
- Network economies of scale
-Risk bearing economies arising from product diversification. - Financial economies e.g lower interest on loans from large firms.
- Marketing Economies of scale.
Economies of scale and fixed costs
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).
How might economies of scale lead to monopoly power?
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.
Why might a firm getting bigger be bad for a firm?
As a firm increases in size, it can encounter diseconomies of scale.
Diseconomies of scale
The cost disadvantages of production on a large scale.
They cause average costs to rise as output rises.
They can be internal or external.
Result from businesses expanding beyond an optimum size and losing productive efficiency.
Examples of external diseconomies of scale
- 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.
Examples of internal diseconomies of scale
- Wastage /inefficiency in large organisation. Bigger warehouses might lead to more things getting lost or mislaid.
- Communication/cooperation may become more difficult as a firm grows, affecting staff morale.
- Managers may be less able to control what goes on.
-Risk adversed salaried staff less willing to take risks.
What is important to understand when discussing economies of scale
its falling long run average cost per unit of production
evaluating economies of scale
- Small businesses can and do survive even if industry is dominated by large firms - niche products.
- Going too big too soon
- All businesses can exploit some internal economies of scale, not very large ones.
What are economies of scope
When it is cheaper to produce a range of products rather than specialise in a limited number e.g. Amazon.
What is the minimum efficient scale (MES)
MES is the lowest level of output at which the minimum possible average cost can be achieved - it’s first point at which the LRAC curve reaches its minimum value. this is likely to be the optimal level of production.
What is some evalution for economies of scale
- Marketing EOS mainly is beneficial to larger firms as they have a much better brand recognition.
what is the economies of sale diagram
WHAT ARE SOME EVALUATIVE POINTS FOR ECONOMIES OF SCALE
- Barriers to Entry:
Large firms benefiting from economies of scale may block smaller firms from entering the market.
Can lead to monopolies or oligopolies, reducing competition and harming consumers. - Not all firms benefit equally:
Some industries (like niche luxury goods or artisan products) don’t benefit much from scale.
Economies of scale are more relevant in capital-intensive industries (like manufacturing)
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Application for economies of scale
Tesla – Technical & Managerial Economies
As Tesla expands, it benefits from technical economies like building massive Gigafactories such as the one in Texas to reduce the cost per car/battery.
It also attracts top talent, gaining managerial economies by employing the best engineers and executives.
