Economies of scale refer to reductions in per unit costs as firm expands its scale of production.

There are two possible causes of economies of scale: internal and external.

Internal economies of scale are the reasons inside the firms that lower the LRAC. It is represented
by the downward sloping of the LRAC curve. Internal economies of scale can be obtained
though specialization of labour which means that employees are divided into various
occupations and production is broken down into stages with specialist employees. Moreover, firm
can use capital intensiveness to assists labour to convert inputs to outputs more easily and quickly.
By-products are another factor that allow firm to achieve economies of scale because with the
production on large scale, there may be sufficient waste products to enable a by-product to be
made. Furthermore, as firms larger, it is able for firm to obtain finance at lower interest rate than
small firms. They may able to purchase inputs at lower price by buying in bulk.

Internal diseconomies of scale are the reasons inside the firm that higher the LRAC. It is presented
by the downward sloping of the LRAC curve. Diseconomies of scale may occur when a firm
grows too large it may become too big to manage efficiently. One part of the firm may find
it difficult to coordinate with the others. This may lead to bottlenecks in production.

External economies of scale occur when a firms cost per unit of output decrease as the size of
the whole industry grows. As an industry grows, other firms achieve their own internal economies of
scale. Lower costs can be passed on to all firms in the industry as lower input costs. Moreover,
locating close to a highly populated area with a supply of skilled labour, close to suppliers of raw
materials or other inputs may be beneficial for firms. Furthermore, other external economies of
scale are government infrastructure. Governments often provide more support to important
industry. This support can be in areas such as provision of infrastructure, industry research,
advertising and education/training. This support helps all firms in the industry to lower their
average costs.