CH7: Economies of scale Flashcards
Definition: Economies of scale
Organisation benefits from discounts because of their (large) size, resulting in an AVERAGE COST PER UNIT which FALLS as OUTPUT INCREASES.
Definition: Diseconomies of scale
When a company becomes less efficient as a result go being too large, resulting in the AVERAGE COST PER UNIT RISES as output increases.
Definition: Short run (economies of scale)
The time period when businesses have some fixed costs ie. costs they cannot change
Definition:Long run (economies of scale)
When all costs faced by a firm are variable (ie. costs that change depending on factors like output)
Economies of scale can be either INTERNAL or EXTERNAL - what are the differences?
Internal economies of scale - caused by factors inside the organisation i.e. they are due to the organisation increasing its own level of output.
External economies of scale- caused by factors outside the organisation, generated either by the growth of the firm’s industry or the economy as a whole.
What are the headings that Internal economies of scale fall under?
i.e. those that come about due to the business increasing its own level of output (as company grows)
- Technical -can afford specialist, efficient machinery that can better deal with large production levels
- Marketing - cost per unit of advertising drops as company grows (output grows but business occurs the same marketing costs)
- Purchasing - bulk buy discounts
- Administrative - one team can serve multiple sites (i.e one accountant for all branches/stores of a business)
- Organisational- split production processes into smaller tasks which will improve efficiency/employee expertise
- Financial - business finance easier/cheaper to obtain as company is owned more credit worthy as it grows
- R&D - internal programme might lead to future cost savings
- Selling - If a company can sell in bulk to a particular outlet it can reduce its distribution costs in terms of transport, Sales personnel and advertising.
What are the headings that External economies of scale fall under?
i.e. those that come about due to the industry the a firm is in growing/or general economy growth
- Skilled labour force - concentration of firms in the same industry in the same area hence pool of skilled labour force
- Suppliers - suppliers may decide to locate in the area where the industry is focussed hence helping reduce transportation costs and increase availability of inputs for the firms
- Infrastructure - development of infrastructure to support local industry
- Technological improvements - development of more efficient technologies to support the industry
- R&D - carried out by third parties with an interest int he growing industry (provision of both external R&D or collaborative)
- Local authority/government spending - helps reduce business and industry costs. e.g. spending on infrastructure improvements or providing subsidies.
What are examples of Internal Diseconomies of Scale?
As the company grows….
- Poor communication
- Motivation - conflict could arise between departments, and employees may have less task ownership
- Duplication of tasks
- Co-ordination - departments need to be able to work well together
- Principal-agent problem - inefficiencies caused by added layers of management are put in place who may have different objectives vs. owners
- Admin costs - may require additional admin systems or personnel
- Technical - when costs of maintaining equipment/machinery exceeds the benefits of increasing capacity
What are examples of external diseconomies of scale?
As the industry or economy grows:
- Natural resources - competition for raw materials increases - shortages and increased prices of resources
- Wages - competition for skilled labour increases wage cost
- Congestion - increased costs in terms of delays or missed deadlines due to congestion
What 3 things do management need to consider to work out the optimum size of the organisation?
- What economies and diseconomies of scale are
- That they exists in their industry
- The impact of economies and diseconomies of scale on costs
What are positive outcomes of economies of scale on an organisation?
Lower costs
Lower prices due to lower costs (customers benefit from this too if the business decided to pass the benefit on to them)
A competitive advantage due to lower costs
Increased profits due to a competitive advantage
Wha are negative outcomes of economies of scale on an organisation?
REDUCED COMPETITION due to barrier to entry for smaller firms, and reduced competition could lead to higher prices
True or Fales?
“Economies of scale generally applies to large companies only?”
True
In terms of economies of scale, what can a growing company do to increase its sales?
It can lower its costs to increase sales.
It can do this because as a company grows and benefits from economies of scale it can buy in bulk to reduce its costs (i.e. average cost per unit decreases and output increases) and then decide to pass this benefit on to its customers.
