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ECONOMIES OF SCALE

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6 views13 pages

ECONOMIES OF SCALE

Uploaded by

tyliqueantoine
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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SUBJECT: PRINCIPLES OF BUSINESS

TOPIC: Economies of scale


OBJECTIVES

Students should be able to;


• Define economies of scale
• Differentiate between the types of economies of scale
• Outline the functions of large scale production
• Outline the functions of small scale production
ECONOMIES OF SCALE
Economies of Scale are the benefits which results in the cost savings of large scale
production/operation or a reduction in unit cost of production when a firm expands.
Types economies of scale
1. Internal
2. External
• Internal: refers to the benefits that will arise to a particular firm.
• External: refers to the benefits that will arise to the entire industry.

Types of Internal Economies of Scale


• Technical economies of scale
• Risk-bearing economies of scale
• Marketing economies of scale
• Financial economies of scale
TYPES OF INTERNAL ECONOMIES OF SCALE
• Technical economies of scale: occurs as output gets larger but the cost
of capital assets don’t rise in proportion to the output.
• Using equipment to full capacity; when the firm was small, the equipment
was underused.
• If the size of a truck doubles, the cost of running the truck does not double.
• Division of labour increases output.

• Risk-bearing economies of scale: a large firm can spread risk by


selling more than one type of good (diversifying), so that if one product
sells slowly the other can pick up the slack.
TYPES OF INTERNAL ECONOMIES OF SCALE
• Marketing Economies: the large firms are able to obtain goods at better rates because they
are able to buy wholesale/large quantities.
• Bulk buying reduces cost
• Specialists can be employed, increasing efficiency and lowering costs.
• Handling and packaging costs do not double if the company doubles its size.

• Financial Economies: the size of the operation will influence the sources of capital. E.g.
banks will prefer to deal with larger, more diversified companies seeing them as less
risky/vulnerable to liquidation/bankruptcy.
• Large firms pay lower rates of interest on loans than small firms, as there is less risk of default
with a large firm possessing significant collateral.
• Large firms can raise capital.
EXTERNAL ECONOMIES

Is where a large firm experience cost savings which are external to the
firm.
Types of external economies of scale
• A supply of skilled labour; may locate near to a firm, causing the
firm to save costs in labour and training.
• Subsidiary economies; these are supporting firms that help to save
cost, e.g. repair and maintenance firms near to an oil refinery.
• Specialized services; when large firms become established, service
industries such as banks, insurance firms, catering companies and
cleaning services locate near to them, savings costs. Normally firms
would have to pay more for these services since they would not be
located near to them.
DISECONOMIES OF SCALE
Occurs when a company or business grows so large that average costs of production increases. It takes
place when economies of scale no longer function for a firm.
Classifying diseconomies of scale
1. Internal
2. External
Internal diseconomies of scale
• Standardization of the product: the large firm may use mass production to produce a standardized
product that reduces customer choice. In addition, standardization inhibits the firm’s ability to adopt to
changing tastes, fashions or trends. This lack of adoptability can cause a reduction in sales.
• Industrial relations: it is easier to unionize a large firm than a small firm. This can prove to be a cost
disadvantage for a firm in terms of wages and strike action.
• Waste: much waste in time and materials goes undetected in very large firms. Costs increases as a
result.
• A large firm is difficult to manage in terms of decision-making and implementation.
• A firm on an expansion path is subject to government intervention, e.g. Price controls or taxes, which
may increase its costs.
EXTERNAL DISECONOMIES OF SCALE
External

• Shortages: scarcity of labour and raw materials drive up prices.


• Pollution and traffic congestion, impact negatively on a firm.
• Decline; the decline of an industry have a ‘ripple effect’, i.e. when
industry is in decline all businesses connected to it can feel its effects.
E.g. the closure of the sugar cane industry will lead to a significant
fall in demand for heavy transportation, sugarcane farmers and bags.
LARGE SCALE PRODUCTION
Refers to the production of a commodity on a large scale with a large sized
firm. It requires huge investments in plant and machinery.

Limits to large scale production


• The size of the market
• The availability of resources
• The Law of Diminishing Returns/Law of Variable Returns
NB: The Law states that if successive amounts of a variable factor is added to a
fixed factor, increasing returns will be achieved up to a certain point. If
additional amounts are added after that point, the additional output achieved
will begin to fall.
CALCUALTING DIMINISHING RETURNS

N.B. Marginal Output: the addition to total output with the employment of an additional
unit of the variable factor.
Increasing & diminishing returns
No. of Worker Total Output Average Output Marginal Output

1 5 5 5

2 18 9 13

3 30 10 12

4 36 9 6

5 35 7 -1
ADVANTAGES & DISADVANTAGES
Benefits of Large Scale Production
• Saving on foreign exchange
• Employment opportunities are created
• Linkages could be formed
• Increased GDP, higher level of production in the country, greater trading
• Earning of foreign exchange (export)
• Increased revenue for the government via taxation
Disadvantages large scale production
• The large firm becomes more bureaucratic
• Management becomes more difficult
• Co-ordination of work become more difficult
• Finding suitable staff (trained) may be a problem
• Motivation of workers become more difficult
SMALL BUSINESS
Is one that is independently owned and operated, is not dominant in its field and does not exceed
specified standards of size.
Characteristics of Small Businesses
1. Management is independent
2. Capital is provided by a single person or small group of persons
3. Products may be sold locally or regionally
4. Size of the firm is small compared to other firms in the industry.

Role of Small Businesses in the Economy


• To satisfy the immediate needs of customers
• Provide specialized goods and services to big businesses
• Are sometimes the sources of new ideas
Problems encountered by small businesses
• Obtaining adequate financing
• Margin of error is very small
• Attracting key personnel to the business
• Managers may lack varied management skills
QUESTIONS FOR STUDENTS

1. What is economies of scale?


2. Differentiate between economies of scale & diseconomies of
scale
3. Identify two types in internal economies of scale

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