Scribd
Upload
60 views3 pages

What Are Economies of Scale

Economies of scale occur when average costs decrease as production increases. They stem from specialization, bulk purchasing discounts, and spreading fixed costs over more units. Diseconomies of scale are the opposite and can arise from overproduction or inefficient management. Whether larger scale is better depends on balancing different sources of economies and diseconomies of scale.

Uploaded by

P Singh Karki
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
60 views3 pages

What Are Economies of Scale

Economies of scale occur when average costs decrease as production increases. They stem from specialization, bulk purchasing discounts, and spreading fixed costs over more units. Diseconomies of scale are the opposite and can arise from overproduction or inefficient management. Whether larger scale is better depends on balancing different sources of economies and diseconomies of scale.

Uploaded by

P Singh Karki
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 3

What Are Economies Of Scale?

When more units of a good or a service can be produced on a larger scale, yet with (on
average) less input costs, economies of scale (ES) are said to be achieved. Alternatively, this
means that as a company grows and production units increase, a company will have a better
chance to decrease its costs. According to theory, economic growth may be achieved when
economies of scale are realized.
Adam Smith identified the division of labor and specialization as the two key means to
achieve a larger return on production. Through these two techniques, employees would not
only be able to concentrate on a specific task, but with time, improve the skills necessary to
perform their jobs. The tasks could then be performed better and faster. Hence, through such
efficiency, time and money could be saved while production levels increased.
Just like there are economies of scale, diseconomies of scale (DS) also exist. This occurs
when production is less than in proportion to inputs. What this means is that there are
inefficiencies within the firm or industry resulting in rising average costs.
Internal and External Economies of Scale
Alfred Marshall made a distinction between internal and external economies of scale. When a
company reduces costs and increases production, internal economies of scale have been
achieved. External economies of scale occur outside of a firm, within an industry. Thus, when
an industry's scope of operations expands due to, for example, the creation of a better
transportation network, resulting in a subsequent decrease in cost for a company working
within that industry, external economies of scale are said to have been achieved. With
external ES, all firms within the industry will benefit.
Where Are Economies of Scale?
In addition to specialization and the division of labor, within any company there are various
inputs that may result in the production of a good and/or service.

Lower input costs: When a company buys inputs in bulk - for example, potatoes used
to make French fries at a fast food chain - it can take advantage of volume discounts.
(In turn, the farmer who sold the potatoes could also be achieving ES if the farm has
lowered its average input costs through, for example, buying fertilizer in bulk at a
volume discount.)

Costly inputs: Some inputs, such as research and development, advertising,


managerial expertise and skilled labor are expensive, but because of the possibility of
increased efficiency with such inputs, they can lead to a decrease in the average cost
of production and selling. If a company is able to spread the cost of such inputs over
an increase in its production units, ES can be realized. Thus, if the fast food chain
chooses to spend more money on technology to eventually increase efficiency by
lowering the average cost of hamburger assembly, it would also have to increase the
number of hamburgers it produces a year in order to cover the increased technology
expenditure.

Specialized inputs: As the scale of production of a company increases, a company can


employ the use of specialized labor and machinery resulting in greater efficiency. This
is because workers would be better qualified for a specific job - for example, someone
who only makes French fries - and would no longer be spending extra time learning to
do work not within their specialization (making hamburgers or taking a customer's
order). Machinery, such as a dedicated French fry maker, would also have a longer
life as it would not have to be over and/or improperly used.

Techniques and Organizational inputs: With a larger scale of production, a company


may also apply better organizational skills to its resources, such as a clear-cut chain of
command, while improving its techniques for production and distribution. Thus,
behind the counter employees at the fast food chain may be organized according to
those taking in-house orders and those dedicated to drive-thru customers.

Learning inputs: Similar to improved organization and technique, with time, the
learning processes related to production, selling and distribution can result in
improved efficiency - practice makes perfect!

External economies of scale can also be realized from the above-mentioned inputs as a result
of the company's geographical location. Thus all fast food chains located in the same area of
a certain city could benefit from lower transportation costs and a skilled labor force.
Moreover, support industries may then begin to develop, such as dedicated fast food potato
and/or cattle breeding farms.
External economies of scale can also be reaped if the industry lessens the burdens of costly
inputs, by sharing technology or managerial expertise, for example. This spillover effect can
lead to the creation of standards within an industry.
But Diseconomies Can Also Occur
As we mentioned before, diseconomies may also occur. They could stem from inefficient
managerial or labor policies, over-hiring or deteriorating transportation networks (external
DS). Furthermore, as a company's scope increases, it may have to distribute its goods and
services in progressively more dispersed areas. This can actually 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 ES or DS
are location specific, trade is used in order to gain access to the efficiencies.
Is Bigger Really Better?
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. Those who
oppose this globalization, as seen in the demonstrations held outside World Trade
Organization (WTO) meetings, have claimed that not only will small business become extinct
with the advent of the transnational corporation, the environment will be negatively affected,
developing nations will not grow and the consumer and workforce will become increasingly
less visible. 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 its consumers.

Moreover, it is feared that competition could virtually disappear as large companies begin to
integrate and the monopolies created focus on making a buck rather than thinking of the
consumer when determining price. The debate and protests continue.
Conclusion
The key to understanding ES and DS 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. Thus, 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 if
its subsequently widened distribution network is inefficient because not enough transport
trucks were invested in as well. Thus, when making a strategic decision to expand, companies
need to balance the effects of different sources of ES and DS so that the average cost of all
decisions made is lower, resulting in greater efficiency all around.

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy