What does economies of scale refer to

For instance, it might be to leave the country because the regulatory costs are too high. As the firm is able to reduce its average cost per unit — it can feed into lower prices for the consumer. Whilst some companies will take all the profits from increased efficiency — firms in a competitive market will pass on some of the cost savings to the customer. As a company grows larger, it often seeks to grow further. Now the best way of doing that is by extending its existing offering and attracting new customers — which leads to greater consumer choice.

In a competitive market, economies of scale can lead to growing wages as firms have lower costs. This is why big firms are able to afford higher salaries than local competitors. As the firm grows, production starts to become more efficient.

In turn, they are able to offer higher wages than competitors to attract the top talent. There are several disadvantages that can occur due to economies of scale. These can present several disadvantages such as:. When a firm grows, it sets up numerous departments for specific tasks. Now that may benefit the firm through the division of labour , but it makes communicating between teams difficult. For instance, who do you speak to if you have a problem with X.

Often in such big companies, you are passed on and on and on again — taking, what should be an easy issue to resolve, significantly longer. As the firm grows, management may go from having one or two delegates, to having 10 or 15 people working under them.

It is far easier to monitor and assist a smaller team rather than keeping tabs on a large workforce. In small companies, there may be a nice community feel whereby everyone knows each other and are all friendly. They are something small and insignificant in this large company — which can contribute to poor employee engagement and performance.

When there are thousands of employees in one firm — it is very easy for two or more people to end up doing the same tasks. This is particularly prevalent when considering poor communication as a factor. On occasion, this has led to boycotts. Yet a small local store doing the same may not face such criticisms.

Quite simply, bigger stores are held to a higher standard. Economies of scale occur when a firm grows in size. An example of such are purchasing economies of scale. The firm benefits from being able to make bulk purchases at a lower price, thereby benefiting from lower costs. Economies of scale are caused by firms growing to a size by which they are able to benefit from a number of efficiencies.

External economies are slightly different from internal in the fact that the occur outside, independently of the firm, but within the industry. So for example, the local council may build a new railway line. The local businesses may benefit from cheaper transport, and potentially a greater influx of new customers. There are both Internal and External economies of scale. Examples include: Internal : 1. Financial Economies 2.

Network Economies 3. Purchasing 4. Division of Labour 5. Technical economies External : 1. Infrastructure 2. Government influence 3. Monopsony Definition Read More ». What is Inflation Read More ».

They could stem from inefficient managerial or labor policies, over-hiring, or deteriorating transportation networks external diseconomies of scale. Furthermore, as a company's scope increases, it may have to distribute its goods and services in progressively more dispersed areas.

This can increase average costs resulting in diseconomies of scale. Some efficiencies and inefficiencies are more location-specific, while others are not affected by area. If a company has many plants throughout the country, they can all benefit from costly inputs such as advertising.

However, efficiencies and inefficiencies can alternatively stem from a particular location, such as a good or bad climate for farming. When economies of scale or diseconomies of scale are location-specific, trade is used to gain access to the efficiencies. There is a worldwide debate about the effects of expanded business seeking economies of scale, and consequently, international trade and the globalization of the economy.

As businesses get bigger, the balance of power between demand and supply could become weaker, thus putting the company out of touch with the needs of their consumers. Also, there's a growing concern that competition could virtually disappear as large companies begin to integrate. As a result, monopolies could emerge with the sole focus of making a profit instead of being consumer-centric. The key to understanding economies of scale and diseconomies of scale is that the sources vary.

A company needs to determine the net effect of its decisions affecting its efficiency, and not just focus on one particular source. While a decision to increase its scale of operations may result in decreasing the average cost of inputs volume discounts , it could also give rise to diseconomies of scale.

For example, a company's expanded distribution network might be inefficient if not enough transport trucks were invested in as well. When making a strategic decision to expand, companies need to balance the effects of different sources of economies of scale and diseconomies of scale, so that the average cost of all decisions made is lower, resulting in greater efficiency all around.

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We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Web Service. OECD Statistics. Economies of scale refers to the phenomenon where the average costs per unit of output decrease with the increase in the scale or magnitude of the output being produced by a firm.

Similarly, the opposite phenomenon, diseconomies of scale, occurs when the average unit costs of production increase beyond a certain level of output. At the point where the average costs are at a minimum, the minimum efficient scale MES of output of a firm or plant is reached. If the quantity demanded in the market is only slightly higher than the quantity at the minimum of the LRAC, a few firms will compete.

If the quantity demanded in the market is less than the quantity at the minimum of the LRAC, a single-producer monopoly is a likely outcome. New developments in production technology can shift the long-run average cost curve in ways that can alter the size distribution of firms in an industry. For much of the twentieth century, the most common change has been to see alterations in technology, like the assembly line or the large department store, where large-scale producers seemed to gain an advantage over smaller ones.

In the long-run average cost curve, the downward-sloping economies of scale portion of the curve stretched over a larger quantity of output. However, new production technologies do not inevitably lead to a greater average size for firms.

For example, in recent years some new technologies for generating electricity on a smaller scale have appeared. The traditional coal-burning electricity plants needed to produce to megawatts of power to exploit economies of scale fully.

However, high-efficiency turbines to produce electricity from burning natural gas can produce electricity at a competitive price while producing a smaller quantity of megawatts or less.

These new technologies create the possibility for smaller companies or plants to generate electricity as efficiently as large ones. Another example of a technology-driven shift to smaller plants may be taking place in the tire industry. A traditional mid-size tire plant produces about six million tires per year. However, in , the Italian company Pirelli introduced a new tire factory that uses many robots. The Pirelli tire plant produced only about one million tires per year, but did so at a lower average cost than a traditional mid-sized tire plant.

Controversy has simmered in recent years over whether the new information and communications technologies will lead to a larger or smaller size for firms. On one side, the new technology may make it easier for small firms to reach out beyond their local geographic area and find customers across a state, or the nation, or even across international boundaries. This factor might seem to predict a future with a larger number of small competitors. Moreover, improved information and communication technologies might make it easier to manage many different plants and operations across the country or around the world, and thus encourage larger firms.

This ongoing battle between the forces of smallness and largeness will be of great interest to economists, businesspeople, and policymakers. Traditionally, bookstores have operated in retail locations with inventories held either on the shelves or in the back of the store.

These retail locations were very pricey in terms of rent. Amazon has no retail locations; it sells online and delivers by mail.

Amazon offers almost any book in print, convenient purchasing, and prompt delivery by mail. Amazon holds its inventories in huge warehouses in low-rent locations around the world. The warehouses are highly computerized using robots and relatively low-skilled workers, making for low average costs per sale.

Amazon demonstrates the significant advantages economies of scale can offer to a firm that exploits those economies. Answer the question s below to see how well you understand the topics covered in the previous section.

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Skip to main content. Module: Production. Search for:. Reading: Economies of Scale Economies of Scale Once a firm has determined the least costly production technology, it can consider the optimal scale of production, or quantity of output to produce.