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Economies of Scale

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. Economies of Scale. Unit Cost. Scale A. 82p. Scale B. 54p. LRAC. MES. Output.

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Economies of Scale

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  1. 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 The Indian Institute of Planning and Management, New Delhi

  2. Economies of Scale Unit Cost Scale A 82p Scale B 54p LRAC MES Output The Indian Institute of Planning and Management, New Delhi

  3. Economies of Scale • Internal – advantages that arise as a result of the growth of the firm • Technical • Commercial • Financial • Managerial • Risk Bearing The Indian Institute of Planning and Management, New Delhi

  4. 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 The Indian Institute of Planning and Management, New Delhi

  5. 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. The Indian Institute of Planning and Management, New Delhi

  6. 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 The Indian Institute of Planning and Management, New Delhi

  7. Economies of Scale • Principle of Multiples: e.g. Company A = 1 of each machine, output per hour = 10 Total Cost = £500 AC = £50 per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60 Total Cost = £1750 AC = £29.16 per unit The Indian Institute of Planning and Management, New Delhi

  8. Economies of Scale Increased Dimensions: e.g. Transport container = Volume of 20m3 Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = £600 per journey AC = £30m3 2m 2m 5m Total Cost = £1800 per journey AC = £11.25m3 4m 4m 10m Transport Container 2 = Volume 160m3 The Indian Institute of Planning and Management, New Delhi

  9. 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 The Indian Institute of Planning and Management, New Delhi

  10. Economies of Scale • Financial • Large firms able to negotiate cheaper finance deals • Large firms able to be more flexible about finance – share options, rights issues, etc. • Large firms able to utilise skills of merchant banks to arrange finance The Indian Institute of Planning and Management, New Delhi

  11. Economies of Scale • Managerial • Use of specialists – accountants, marketing, lawyers, production, human resources, etc. The Indian Institute of Planning and Management, New Delhi

  12. Economies of Scale • Risk Bearing • Diversification • Markets across regions/countries • Product ranges • R&D The Indian Institute of Planning and Management, New Delhi

  13. 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 The Indian Institute of Planning and Management, New Delhi

  14. 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 • Reputation • Local knowledge and skills • Infrastructure • Training facilities The Indian Institute of Planning and Management, New Delhi

  15. Assignment • For each of the five main sources of internal economies of scale (technical, commercial, financial, managerial, risk bearing) think of an example of how these could apply to the electronics/electrical good industry and explain your reasoning. • What disadvantages might there be for consumers of firms experiencing economies of scale? • Why might economies of scale be inappropriate, undesirable or inaccessible for some firms? The Indian Institute of Planning and Management, New Delhi

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