Economies of Scale

Economies of Scale Meaning

Economies of scale refer to the cost advantage that the business achieves due to large scale of production and higher efficiency level. Generally, larger firms reap out more benefits and cost advantages over small firms as they have larger outputs and can spread their average cost (fixed and variable) over a greater number of units of output.

Explanation

Businesses achieve economies of scale due to the large scale of production. Several other factors that help larger firms in achieving the economies of scale are specialisation in terms of the product line and labour, bulk ordering from suppliers at a reduced price, investment in advertising and research, lowering the cost of capital by borrowing funds cheaply, and so on.

Another related phenomenon is known as diseconomies of scaleDiseconomies Of ScaleDiseconomies of scale is a state that generally occurs when an enterprise expands in size. The average operating cost increases due to inefficiency in the system, employee incoordination, administration & management issues, and delayed decisions.read more, which happens due to inefficiency in existing production or other processes within the firm or entire industry. It will lead to an increase in average cost even after the output is increasing.

Economies of Scale

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Source: Economies of Scale (wallstreetmojo.com)

Examples of Economies of Scale

Types of Economics of Scale

There are two main types –

  • External Economies of Scale: External economies of scale are achieved due to external factors such as tax reductions, government subsidies, improves transportation network, etc.
  • Internal Economies of Scale: Internal economies of scale happens due to factors internal to the firm. For example, investment in highly efficient machinery, hiring of the specialised workforce or holding a patent over something unique like production machinery. It leads to a reduction in average cost and competitive advantage.

Determinants

  • Businesses producing at large scale achieve specialisation in their production line generally by breaking down the job into smaller tasks. It leads to increased efficiency and reduced average cost.
  • Due to the large scale of production, the firms can negotiate on buying resources at less cost.
  • They can borrow funds easily due to the easy availability of collateral.
  • They start investing money in research and development.

Benefits

Effect

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