Economies of sale Flashcards
What is economies of sale?
Economies of scale are the cost advantage from business expansion. Economies of scale means large organisations can often produce items at a lower unit cost than their smaller rivals - a source of competitive advantage.
As some firms grow in size their unit costs begin to fall because of?
purchasing economies - when large businesses often receive a discount because they are buying in bulk
marketing economies - from spreading the fixed cost of promotion over a larger level of output
administrative economies - from spreading the fixed cost of management staff and IT systems over a larger level of output
research and development economies - from spreading the fixed costs of developing new or improved products over a larger level of output
What are fixed costs?
Fixed costs are expenses that do not change with the level of output. Large firms have lower unit costs than small firms because these fixed costs are spread more thinly over higher sales volumes. For instance, take a £1 million advertising campaign. If just two items are sold the unit cost of promotion is half a million pounds. If a million items are sold the unit cost falls to just one pound. Many economies of scale are about spreading fixed costs more thinly.
Whats the difference between total costs and average cost?
It is important not to confuse total cost with average cost. As a firm grows in size its total costs rise because it is necessary to use more resources. However, the benefits of becoming bigger can mean a fall in the average cost of making one item.
How do small firms operate?
Small firms compete in two ways. They either operate in service industries such as hairdressing where there are few opportunities for economies of scale, or they offer high priced, premium, niche products. Customers are prepared to pay more for exclusive goods made by small businesses.
A business can become so large that its unit costs begin to rise. Expanding firms can experience diseconomies of scale. What are the causes?
Ineffective communication. Coordinating large numbers of staff becomes a challenge. Big businesses can develop many levels of hierarchy which slow down communication or even lead to miscommunication.
Reduced motivation. Staff can feel remote and unappreciated in a large organisation. When staff productivity begins to fall, unit costs begin to rise.
