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IB Business & Management

ECONOMIES OF SCALE (EOS) This refers to the fall in average cost of production or unit cost of production when output of a firm increases. In other words, they are the advantages of growing ‘big’. The costs per unit usually decrease because the total costs of the business are spread over a larger amount of output. Economies of scale can be of 2 types: (i) (ii) Internal EOS (Occurs when the firm [individual business] grows in size) External EOS (Occurs when the industry [collection of firms] grows in size)

TYPES OF INTERNAL ECONOMIES OF SCALE Marketing EOS Average costs may be lowered when businesses increase sales because of large scale production. Advertising and any other costs associated with marketing may be lower per unit because these costs are spread over a larger amount of output. It will be the same case for transportation where large businesses can transport more goods at a time causing the transportation cost per unit to be lower as compared to small businesses. Bulk buying EOS / Commercial EOS / Purchasing EOS As a firm grows in size, more raw materials will be needed for mass production. Hence, bulk buying will take place. As such, discounts are negotiated and this helps the business to decrease the costs of its inputs (raw materials). This will help businesses to benefit from lower average costs per unit. Technical EOS Large scale production allows a more efficient use of machinery and equipment. The latter will not be idle and mass production will allow the average cost of production to fall. Modern and up to date machinery might also be purchased for large scale production and this will allow rapid and more effective production. Financial EOS Larger firms have more power to influence financial institutions. They can negotiate for lower rate of interest and borrow massive sums of money. This is because financial institutions see them as being less risky than smaller firms. Large firms are trusted to be able to pay back the money without major difficulties. Smaller firms have problems to get loans from the banks because of the risk factor. They are also not allowed for lower rate of interest.

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IB Business & Management

Managerial EOS By becoming ‘bigger’, firms can employ specialists. One person will not be responsible for managing the business as a whole. Instead, the management functions will be distributed according to the area of specialization that the human resources possess. Large firms can afford to pay such specialists and they may help the business to boost up productivity by a better and more effective management. This will help costs of the business to fall. Specialisation EOS This EOS may be classified as Managerial EOS but there is a slight difference in the sense that here, the focus in on the workforce rather than the management. It occurs when specialist workers are employed, for example engineers. Division of labour can easily be practiced in large organizations and the specialists help the business to do it in a more cost effective manner.

TYPES OF EXTERNAL ECONOMIES OF SCALE Improved transportation Growth of an industry will benefit an individual firm as far as transportation is concerned. This will be helpful for deliveries of the firm be it from the supplier or to the market. It will also allow employees to be punctual to work and as such decrease cost of the business. Improved financial services Financial institutions can set up different schemes for firms because of a growth of the industry. Loans will be more readily available as well as other services. Businesses will not struggle finding sources of finance and regulations regarding financial transactions will also improve causing less wastage of time. Setting up of education & training institutions When the industry expands, training facilities become more reachable. Universities or training institutions may tailor specific programmes to help individual businesses. The community also has access to those institutions and therefore the firm can benefit from a pool of trained workforce which will help the business to operate successfully in the most cost effective manner. This will also help businesses to reduce the cost of recruitment and training.

© GOOROOCHURN Kentish

kentishgooroochurn@yahoo.com

IB Business & Management

DISECONOMIES OF SCALE (DEOS) There is a point up to which economies of scale might be reaped. If the business becomes too ‘big’, economies of scale might start to disappear. This is because of various disadvantages of being too large in size. Diseconomies of scale can be defined as those factors which lead to higher cost per unit because of an outsized business. Diseconomies of scale can be of 2 types: (i) (ii) Internal DEOS (Occurs because of managerial problems) External DEOS (Occurs because of factors not within the control of an organisation)

TYPES OF INTERNAL DISECONOMIES OF SCALE Communication problems By growing too large, the level of hierarchy in the business increases. This might lead to communication problems where messages might be wrongly interpreted or not sent to the right person concerned. Management and staff will not be able to interact on a regular basis and this sort of barrier may cause work to be carried out in a disorganized way leading to an increase in the average cost of production. Lack of control Management will have less time to interfere directly with the work that employees are carrying out. This results in lack of control and coordination. Productivity of the business may as such be affected negatively and this leads to increased cost of operations. Poor working relationship Morale of the staff may be affected because of the barrier between management and them in large organizations. This will impact on their performance and motivation. This further impacts on productivity and again cause costs of the business to increase. Bureaucracy Costs of the business may rise because of increased paperwork, administration matters and policies. Decision making will be slowed down as such causing the costs to increase.

© GOOROOCHURN Kentish

kentishgooroochurn@yahoo.com

IB Business & Management

TYPES OF EXTERNAL DISECONOMIES OF SCALE Traffic congestion As firms increase in size, they set up in particular regions. It might also be that the suppliers move near to them. This will cause traffic congestion problems causing delays and increase the cost of the business. It will not affect only one firm but may affect an industry as a whole. Labour competition Since many firms in the industry have grown in size, it might be difficult to recruit the best workers and retain them. Competitors may offer better packages to workers and the cost of recruitment will be high. High wages will also have to be offered because of the competition.

© GOOROOCHURN Kentish

kentishgooroochurn@yahoo.com