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Economies and diseconomies of scale
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As businesses grow, their average costs often fall. But if they grow too big, average costs can start to rise again.
Internal economies of scale
Economies of scale are falling average (unit) costs as output increases.
Internal economies come from the business's own growth:
Purchasing: bulk-buying discounts.
Technical: affording more efficient machinery.
Financial: borrowing more cheaply.
Marketing: advertising costs spread over more sales.
Managerial: hiring specialist managers.
Internal economies come from the business's own growth:
Purchasing: bulk-buying discounts.
Technical: affording more efficient machinery.
Financial: borrowing more cheaply.
Marketing: advertising costs spread over more sales.
Managerial: hiring specialist managers.
External economies of scale
External economies come from outside the business, when the whole industry grows in an area: a pool of skilled workers, nearby suppliers, better infrastructure and specialist training.
Diseconomies of scale
Diseconomies of scale are rising average costs as a business becomes too large.
Communication problems across many levels and sites.
Coordination and control become harder.
Motivation falls as workers feel unimportant.
These set the limits of growth.
Communication problems across many levels and sites.
Coordination and control become harder.
Motivation falls as workers feel unimportant.
These set the limits of growth.
Total costs are £50 000 for 10 000 units. After growth, total costs are £80 000 for 20 000 units. Has the business gained economies of scale?
- Before: 50 000 ÷ 10 000 = £5 per unit
- After: 80 000 ÷ 20 000 = £4 per unit
Answer: Yes, average cost fell from £5 to £4.
Economies of scale: falling average costs as output grows (purchasing, technical, financial, marketing, managerial; plus external). Diseconomies: rising average costs from communication, control and motivation problems.
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