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Economies and diseconomies of scale
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As firms grow, average costs usually fall at first. But firms can become too big, and average costs rise.
Internal economies of scale
Economies of scale are the cost advantages of growing: average cost falls as output increases.
Internal economies come from the firm's own growth:
Purchasing (bulk buying), marketing (costs spread over more sales), technical (more efficient machinery), financial (cheaper borrowing), managerial (specialist managers) and risk bearing (spreading risk over many products or markets).
Internal economies come from the firm's own growth:
Purchasing (bulk buying), marketing (costs spread over more sales), technical (more efficient machinery), financial (cheaper borrowing), managerial (specialist managers) and risk bearing (spreading risk over many products or markets).
External economies of scale
External economies come from the growth of the industry, often in one area:
skilled labour available locally, better infrastructure, access to suppliers, and the clustering of similar businesses (sharing ideas and services).
skilled labour available locally, better infrastructure, access to suppliers, and the clustering of similar businesses (sharing ideas and services).
Diseconomies and the LRAC curve
Diseconomies of scale are when average costs rise as the firm grows too large: bureaucracy, communication problems, lack of control, and distance between top managers and workers lowering motivation.
The long run average cost (LRAC) curve is U-shaped: it falls (economies), reaches a minimum (the point of maximum efficiency), then rises (diseconomies).
The long run average cost (LRAC) curve is U-shaped: it falls (economies), reaches a minimum (the point of maximum efficiency), then rises (diseconomies).
A firm's average cost falls from £10 to £8 when output doubles, then rises to £9 when output doubles again. Explain.
- The first fall is economies of scale.
- The later rise is diseconomies of scale.
Answer: Economies of scale, then diseconomies of scale.
Internal economies: purchasing, marketing, technical, financial, managerial, risk bearing. External: skilled labour, infrastructure, suppliers, clustering. Diseconomies: bureaucracy, communication, control, distance. LRAC is U-shaped.
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