ECONOMIES OF SCALE: The increase in efficiency of production as the number of goods being produced increases.

Typically, a company that achieves economies of scale lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods. Economies of scale give big companies access to a larger market by allowing them to operate with greater geographical reach. For the more traditional (small to medium) companies, however, size does have its limits. After a point, an increase in size (output) actually causes an increase in production costs. This is called "diseconomies of scale". Minimum efficient scale The minimum efficient scale (MES) is the scale of production where the internal economies of scale have been fully exploited. It corresponds to the lowest point on the long run average cost curve and the output that achieves productive efficiency. The MES usually covers a range of output levels where the firm achieves constant returns to scale and has reached the lowest feasible cost per unit in the long run. There are two types of economies of scale: -External economies - the cost per unit depends on the size of the industry, not the firm. -Internal economies - the cost per unit depends on size of the individual firm. Internal economies of scale:

Technical economies of scale:

Expensive specialist capital machinery e.g. robotic technology in the production of vehicles Specialization of the workforce to boost factor productivity – division of labor The law of increased dimensions or the “container principle” Learning economies e.g. learning by doing: Unit costs of production typically decline in real terms as a result of production experience as businesses improve their production methods and cut waste. Evidence across a wide range of industries into so-called “progress ratios”, or “experience curves”, indicate that unit manufacturing costs typically fall by between 70% and 90% with each doubling of cumulative output


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external economies of scale are said to have been achieved. . In contrast. as they are more widely used (or adopted). Another good example is the development of research and development facilities in local universities that several businesses in an area can benefit from. The marginal cost of adding one more user to the network is close to zero. External economies of scale (in an industry) External economies of scale occur when an industry's scope of operations expand due to for example the creation of a better transportation network. Think about network economies exploited by EBAY in online auctions and the rapid expansion of air transport networks by the low-cost airlines.000 motorcycles a year instead of a possible 1 million. With this circumstance. smaller firms often face higher rates of interest on their overdrafts and loans. but the resulting financial benefits may be huge because each new user to the network can then interact.• Marketing economies of scale and monopsony power : A large firm can spread its advertising and marketing budget over a much larger output and it can also purchase its factor inputs in bulk at discounted prices if it has monopsony power in the market (monopsony power is becoming important) • Financial economies of scale: Larger firms have access to credit facilities. trade with all of the existing members or parts of the network. Businesses quoted on the stock market can normally raise fresh money (extra financial capital) more • Network economies of scale: Some networks and services have huge potential for economies of scale. the need for an assembly line would become obsolete. The result of using these technologies is that costs of production are reduced significantly while quality control is kept to a very high level with virtually zero defects. with favorable rates of borrowing. the relocation of component suppliers and other support businesses close to the main centre of manufacturing are also an external cost saving. Likewise. resulting in a subsequent decrease in cost for a company working within that industry. For example. they become more valuable to the business that provides them. That is. a company like Gillette or BIC operates with very large modern factories using automated production technology. Honda was constrained to produce only 10.

and meatpacking firms produce fertilizers. large oil firms often produce a host of petroleum by-products. Honda could rule out benefits that might be derived from the division and specialization of labor. the costs of providing each service separately would be much greater than the costs of using a single infrastructure to provide multiple services. the sale of by-products effectively reduces the per-unit costs of producing lumber in large volumes.Each motorcycle could be produced by hand. Honda and General Motors have enjoyed economies of scale with reduced average cost simply in a way that they have increased their scale of their operations. the use of any production techniques that reduce average cost would become obsolete. Wood scraps may be packaged. In these two examples. . ATMs. Expanding the product range to exploit the value of existing brands is a good way of exploiting economies of scope. the primary ingredient in paper. In producing such a small number. their branches. In another example. sports goods or McDonald’s expanding the range of their products to include salads and health foods.g.. In the paper products industry it is common for large firms to produce their own pulp. although the large companies probably also have economies of scale that make it feasible to invest in pulping operations in the first place. glue. banks have economies of scope when they offer a variety of related financial services. leather. E. through a single service infrastructure (i. and Internet site). The savings from producing both pulp and paper would be an economy of scope for the large producers. smaller firms may have to purchase pulp from others at a higher net cost than the large companies pay. Sawdust can be sold as a sweeping compound for cleaning floors and hallways in large buildings. Clearly. In this way. Amazon expanding into selling toys. processed. and other by-products of meat production. before manufacturing the paper goods themselves. ECONOMIES OF SCOPE: Economies of scope occur where it is cheaper to produce a wider range of products rather than specialize in just a handful of products. For the same reasons.e. and sold as kindling wood and artificial logs for home barbecues and fireplaces. However. such as retail banking and investment services.

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