3.3.3: Economies and Diseconomies of Scale

Question 1

What are economies of scale?

Answer 1

• the cost advantages companies gain from increasing their output
• lower long run average costs as there is an increase in output

Question 2

What are diseconomies of scale?

Answer 2

• the cost disadvantages that companies experience due to an increase in output, e.g rising long run avergae costs/ increase in average unit costs

Question 3

What are constant returns to scale?

Answer 3

• where firms increase inputs and receive an increase in output by the same percentage

Question 4

What is the minimum efficient scale (MES)?

Answer 4

• 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 off and when constant returns to scale is first met.

Question 5

What are internal economies of scale?

Answer 5

• advantages that a firm are able to enjoy because of a growth in the firm, independent of anything happening to other firms or the industry in general

Question 6

What are different types of internal economies of scale?

Answer 6

• Technical
• Bulk Buying
• Marketing
• Specialisation
• Risk Bearing
• Financial

Question 7

What are technical economies of scale?

Answer 7

• the lower unit costs due to the expansion of the factors of production/ production process
• this includes specialisation, balanced teams of machines, increased dimensions, indivisibility of capital and research & development

Question 8

How does specialisation & division of labour cause IEoS?

Answer 8

• Large firms will be able to appoint specialist workers and buy specialist machines which will be able to do their jobs more quickly; and production of goods and services will be more efficient
• With specialist workers, firms will also spend less money on training, as workes will be training for specialist/ specific tasks.

Question 9

How do balanced teams of machines cause IEoS?

Answer 9

• Large firms can afford to buy a number of every kinf of machine for each stage of production.
• By combining these machines, they can ensure they run each machine at its optimal level.

Question 10

How does indivisibilty of capital cause IEoS?

Answer 10

• Indivisibility of capital refers to where certain types of capital goods such as large machinery, factories etc cannot be divided into smaller units without losing their efficiency
• Indivisibility of capital helps firms have fixed costs of production no matter the level of production and increased efficiency due to the use of specialist machinery

Question 11

How does research and development lead to IEoS?

Answer 11

• Large scale research and development causes a firm to gain large competitive advantage
• R&D can help firms develop new technologies amnd process innovation, which can streamline and scale up production, lowering long run average unit costs
• Bargaining power: firms that usually invest in R&D often grow larger over time, increasing their purchasing power and ability to negotiate better terms with suppliers, leading to lower LRA costs.

Question 12

What are financial economies of scale?

Answer 12

• the cost advantages that a firm experiences as it grows in size and can access more favorable financial conditions.
• Large firms have greater security because they have more assets, making it easiedr for them to acces finance.
• As a firm increase it’s scale of operations, it can often obtain better financial terms such as lower interest rates and larger loans, due to their reputation.
• This causes the firms to have use financial resources more efficiently, leading to overal lower financial costs.

Question 13

What are risk bearing economies of scale?

Answer 13

-the ability of larger firms to spread and manage risks more effectively than smaller firms
- Diversification of risk: large companies are able to operate in a range of different markets, reducing the risk of experiencing risks such as fluctuations in demand, economic downturns and supply chain distributions
- A larger firm can also spread their fixed costs over a number of operations

Question 14

What are managerial economies of scale?

Answer 14

• the cost savings and efficiency gains that a company achieves by employing specialized management as it grows in size.
• large companies can afford to have specialist managers in every field, who have greater knowledge and are able to do the job better.
• Staff represent an Indivisibility and so small firms cannot employ specialist staff

Question 15

What are external economies of scale?

Answer 15

• advantages which arise from the growth of the industry within which the firm operates

Question 16

How is labour an external economy of scale?

Answer 16

• Businesses established in an area with other successful firms from the same industry find that labour tends to come to that area if they want a job in that industry,eg Silicon Valley. This reduces the costs andtime taken to recruit.
• Another advantage for large industries is that local education and training providers are more likely to develop courses to prepare people to take jobs in these businesses.
• Firms will be able to hire staff who have been trained by other businesses, which is cheaper and more efficient for the firm than training the workers themselves.

Question 17

How are support services external economies of scale?

Answer 17

• Businesses who provide products or services for large businesses will naturally move to the area where those businesses are based, which reduces transport cost/time delays for the business.