Economies & Diseconomies of Scale (Edexcel IGCSE Economics)
Exam board Pearson Edexcel · IGCSEUpdated 2024-06-10
Introduction to Economies & Diseconomies of Scale
Spec point —
1.2.3b
-
As a firm grows, it is able to increase its scale of output generating efficiencies, that lowers its average cost of production (AC)
- These efficiencies are called economies of scale
- Economies of scale help large firms lower their production costs beyond what small firms are able to achieve
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As a firm continues to increase its scale of output, it will reach a point where its average costs (AC) will start to increase
- The reasons for the increase in average costs are called diseconomies of scale
Diagram: long-run average cost curve
Economies and diseconomies of scale
Diagram analysis
- With relatively low levels of output, the firm's average costs are high
- As the firm increases its output, it begins to benefit from economies of scale, which lower the average cost per unit
- At some level of output, a firm will not be able to reduce costs any further; at this point the firm achieves its greatest efficiency
- Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale
Internal Economies of Scale
Spec point —
1.2.3c
- Internal economies of scale occur as a result of the growth in the scale of production within the firm
Types of Internal Economies of Scale
| Internal Economy of Scale | Explanation |
|---|---|
| Purchasing | - This occurs when large firms buy raw materials in greater volumes and receive a bulk purchase discount, which lowers the AC |
| Managerial | - It occurs when large firms can employ **specialist managers **who are more efficient at certain tasks, and this efficiency lowers the AC - Managers in small firms often have to fulfil multiple roles and are less specialised |
| Marketing | - Large firms spread the cost of advertising over a large number of sales, and this reduces the AC - They can also reuse marketing materials in different geographic regions, which further lowers the AC |
| **Financial ** | - Large firms often receive lower interest rates on loans than smaller firms, as they are perceived as less risky - A cheaper loan lowers the AC |
| Technical | - Occur as a firm is able to use its machinery at a **higher level of capacity **due to the increased output - Thereby spreading the cost of the machinery over more units and lowering the AC |
| Risk bearing | - It occurs when a firm is able to spread the risk of failure by increasing its numbers of products - Leads to greater** product diversification**; less failure lowers AC |
External Economies of Scale
Spec point —
1.2.3b
- As a firm continues to increase its scale of output in the long-run,external changes will occur in the locality and in the industry that will help to lower the firm's average costs (AC)
Sources of External Economies of Scale
| Source | Explanation |
|---|---|
| Skilled labour | - As the firm grows, local educational establishments will provide relevant qualifications to that industry - The firm can employ workers who are already skilled, saving on training costs |
| Infrastructure access | - Local authorities may build access roads near large firms to ease delivery vehicle and shift worker traffic |
| Local suppliers | - Key suppliers may relocate to be near their largest customer to cut delivery costs and lead times |
| Similar businesses are in the area | - As a firm grows, other similar businesses relocate to this area to take advantage of the external factors that lower AC |
Internal Diseconomies of Scale
Spec point —
1.2.3c
- Internal diseconomies of scale occurs when an increase in the scale of output results in a higher cost per unit due to factors generated inside of the business
Types of Internal Diseconomies of Scale
| Bureaucracy | - Large firms have significant amounts of paperwork, rules and regulations - This slows down decision making and production, raising AC |
|---|---|
| Communication | - Accurate communication breaks down when large numbers of workers are involved, leading to inaccuracies and confusion, raising AC |
| Control | - Large numbers of workers and many product lines become difficult to control - A lack of coordination between aspects of production can raise AC |
| Distance between management and workers | - A large firm is likely to have many layers of hierarchy - Messages are miscommunicated and misinterpreted through the layers, raising AC |
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