Economies of Scale
Internal Economies of Scale
Internal EOS are cost savings that a firm enjoys when it increases its scale of production. This can be represented by a fall in unit cost of production as shown by a downward movement along the Long Run Average Cost(LRAC) curve. This point is called the Minimum Efficiency Scale (MES), which is the minimum output a firm needs to produce to achieve lowest LRAC.
Technical EOS
Gained through specialisation and division of labour.
Firms with output sufficiently large can breakdown their production process into different tasks->allow for division of labour->increase efficiency when allowing workers to specialise->save time from repeating tasks->increase output per unit time->increase productivity->decrease in LRAC.
Gained through indivisibility of capital equipment.
Capital equipment indivisible->not possible to buy in smaller units->too large for small firms to buy in smaller units->only large firms can reap EOS using machinery as total cost of each indivisible input is spread across larger output.
Marketing EOS
Gained through bulk buying.
larger firms tend to buy larger quantity of inputs->stronger position to negotiate discounts->fall in LRACas output increases->more bargaining power than smaller competitors to negotiate lower prices with suppliers.
Gained through advertising.
Total expenditure on advertising is spread over a larger number of output sold.
Managerial EOS
Firm grows->hire professionals to specialise in different areas of work->set up different departments->better decision making->fall in LRAC->prevent losses.
Financial EOS
Larger firms->better credit ratings->have more assets to pledge as collateral to banks->less risky for banks to lend money->borrow more cheaply->further reap EOS as interest rates of borrowing decreases->fall in cost of borrowing.
2. External Economies of Scale
Economies of concentration
Lower Transport & Communication Costs: When an industry grows and roots itself in a particular region (think of technology firms in Silicon Valley and film studios in Hollywood), the government may provide better transport and communciations infrastructure in the area, which can lower transport and communication costs.
Increased Education Focus on the Industry: it is common for schools and universities in a country to offer courses suitable in training one in preparation for a career in an industry that has become established in a region or in the country. This will allow firms to have a larger pool of skilled labour for firms to recruit for.
Other Industries Grow to Support This Industry: A network of suppliers or support/ancillary industries may grow in size and/or locate close to the main industry. This lowers transport costs and also makes it easier for firms to find support services.
3. Diseconomies of Scale
Diseconomies of Scale occur when a business grows too large so that the costs per unit increase.
Poor communication
As firms grow larger, communications across the full chain of command becomes tedious.
Workers may become less clear on what they need to do and thus be less productive.
Lack of motivation
Large firms often feel imperonal in terms of communications, and workers may feel less appreciated.
Poorer employee motivation may thus affect quality of good produced or output levels.