Economies of Scale Asst. Prof. Dr. Serdar AYAN

1. Economies of ScaleAsst. Prof. Dr. Serdar AYAN

2. Economies of Scale • The advantages of large scale production that result in lower unit (average) costs (cost per unit) • AC = TC / Q • Economies of Scale – spreads total costs over a greater range of output.

3. Economies of Scale • Internal Economies of Scaleadvantages that arise as a result of the growth of the firm • Technical • Commercial • Financial • Managerial • Risk Bearing

4. Economies of Scale • External Economies of Scale – the advantages firms can gain as a result of the growth of the industry – normally associated with a particular area • Supply of skilled labour • Local knowledge and Skills • Infrastructure • Training facilities

5. Economies of Scale Assume each unit of capital = 5TL, Land = 8TL and Labour = 2TL Calculate AC for the two different ‘scales’ (sizes’) of production facility What happens and why?

6. Economies of Scale Doubling the scale of production (a rise of 100%) has led to an increase in output of 200% - therefore cost of production PER UNIT has fallen Don’t get confused between Total Cost and Average Cost, Overall ‘costs’ will rise but unit costscan fall. Why?

7. Economies of Scale • Internal: Technical • Specialisation – large organisations can employ specialised labour • Indivisibility of plant – machines can’t be broken down to do smaller jobs! • Principle of multiples – firms using more than one machine of different capacities more efficient • Increased dimensions – bigger containers can reduce average cost

8. Economies of Scale • Indivisibility of Plant: • Not viable to produce products like oil, chemicals on small scale – need large amounts of capital • Agriculture – machinery appropriate for large scale work – combines etc,

9. Economies of Scale • Principle of Multiples: • Some production processes need more than one machine • Different capacities • May need more than one machine to be fully efficient

10. Economies of Scale • Principle of Multiples: EG

11. Economies of Scale • Principle of Multiples: EG Company A = 1 of each machine, output per hour = 10 Total Cost = 500TL AC = 50TL per unit

12. Economies of Scale • Principle of Multiples: EG Company A = 1 of each machine, output per hour = 10 Total Cost = 500TL AC = 50TL per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60 Total Cost = 1750TL AC = 29.16TL per unit

13. Economies of Scale Increased Dimensions Transport container 1 = Volume of 20m3 Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 600TL per journey AC = 30m3 TL 2m 2m 5m Total Cost = 1800TL per journey AC = 11.25m3 TL 4m 4m 10m Transport Container 2 = Volume 160m3

14. Economies of Scale • Commercial • Large firms can negotiate favourable prices as a result of buying in bulk • Large firms may have advantages in keeping prices higher because of their market power

15. Economies of Scale • Financial • Large firms able to negotiate cheaper finance deals • Large firms able to be more flexible about finance • Large firms able to utilise skills of merchant banks to arrange finance

16. Economies of Scale • Managerial • Use of specialists – accountants, marketing, lawyers, production, human resources etc

17. Economies of Scale • Risk Bearing • Diversification • Markets across regions/countries • Product ranges • R&D

18. Diseconomies of Scale • The disadvantages of large scale production that can lead to increasing average costs • Problems of management • Maintaining effective communication • Co-ordinating activities – often across the globe! • De-motivation and alienation of staff • Divorce of ownership and control