CIE IGCSE

UNIT 3.5.5 ECONOMIES & DISECONOMIES

OF SCALE
MISS PATEL
 WHAT ARE ECONOMIES OF SCALE?
They are cost savings from increasing the scale of production in a firm or industry

Internal economies of scale

Increasing the size of a firm provides an

opportunity to change the way it is organized,
run and financed to reduce the average or unit
cost of production
External economies of scale
These are cost savings enjoyed by firms in large
industries compared to firms in smaller
industries. External growth reduces risk by
merging with EXISTING ESTABLISHED firms and
increases the rate of growth and uses less fixed
capital costs.
 INTERNAL ECONOMIES OF SCALE – EXAMPLES?
• PURCHASING ECONOMIES e.g. discounts for bulk purchases. Ability to
negotiate lower input costs leading to lower unit costs.
• MARKETING ECONOMIES e.g. mass advertising; own distribution network.
This is only affordable and feasible at large scale.
• FINANCIAL ECONOMIES e.g. ability to borrow more at lower interest rates.
Large established firms are deemed as being lower risk and will have a
better credit score.
• TECHNICAL ECONOMIES e.g. ability to afford and employ advanced
equipment and technology, to operate more efficiently. This is due to the
ability of the firm to spread the fixed cost over a larger number of units
sold, reducing average cost of new equipment.
• RISK-BEARING ECONOMIES e.g. offering a range of different products is
only possible with a large and varying market. If one product fails. Fixed
costs can be spread over the units sold of other products.
 EXTERNAL ECONOMIES OF SCALE
These are cost savings enjoyed by firms in a large industry. These may be:

•Access to a skilled workforce because firms can recruit workers trained by

other firms in their industry. As the cluster attracts specialist workers and
specialist training schools in the regions.

•Ancillary firms that develop and locate nearby large firms in other
industries to provide them with the specialized equipment and business
services they need, as specialist supplier firms set up in the region.
Agglomeration!

•Joint marketing benefits: for example, new firms locating near to others in
the same industry may share their reputation for producing high-quality
products

•Shared infrastructure: for example, the growth of an industry may

persuade firms in other industries to invest in new infrastructure such as
power stations, dock facilities and airports to meet increasing demand for
these services. Agglomeration!
ECONOMIES OF SCALE ACTIVITY
• Working in groups of 4, give short examples to explain the 5 types of internal, 4
external economies of scale, and 5 diseconomies of scale.
 WHAT PROBLEMS MAY ARISE WHEN FIRMS GET TOO BIG?
• 1. Management of labour becomes difficult—communication barriers
with too many staff. Too many layers of managers. Loss of efficiency.
• 2.—lateral integration (merging between firms with different products)
that creates confusion between companies, employees, units and
departments. Coordination failures. especially if it has many locations,
thus different time zones, language barriers, or many managers and
many different activities.
• 3. Labour—too many workers. Workers do not feel connected to the
company value. Alienated from the final output. They become
demotivated and productivity suffers.
• 4. Divorce of ownership and control – owners lose control over the firms
objectives and ethos. The company is run by directors not shareholders.
Conflict of interests arise between managers and owners
• 5. Loss of personal touch and strong customer relations, which can have
a negative impact on brand loyalty/customer retention. Thus LR profit
THE ABOVE INEFFICIENCY OUTCOMES MAY LEAD TO RISING AVERAGE
COSTS – DIS-ECONOMIES OF SCALE!
ACTIVITY
• Discuss activity 4.16 page 247
RETURNS TO SCALE – NOT THE SAME AS ECONOMIES OF
SCALE!!
Increasing returns to scale Constant returns to scale Decreasing returns to
scale
A firm doubles all its A firm doubles all its A firm doubles all its inputs
inputs inputs

Output more than doubles Output fails to double

Output doubles

Therefore, cost per unit Cost per unit rises

falls Cost per unit is unchanged
ACTIVITY
• Complete activity 4.17
 RECAP! WHY DO SOME FIRMS REMAIN
SMALL?

• It may be because the market is a small,

local or specialized niche market

• A small firm may be unable to raise enough

capital to expand

• New technology may have reduced the

scale of production needed in some sectors

• The owner may prefer keep the business

small to keep control and avoid a division
of ownership and control
▲Smaller firms can often
provide more personalized • Avoid diseconomies of scale.
goods and services than
many larger firms
APPLICATION: DESCRIBE THE REASONS WHY SMALL FIRMS
ARE OFTEN SUCCESSFUL IN THE RETAIL TRADE (CLOTHING
BUSINESS) IN MANY COUNTRIES?

• (c) Possible reasons:

• • amount of capital to finance growth
• • organisation of the business, e.g. sole trader
• • personal choice/preferences of owner(s)
• • government regulation/assistance
• • customer preference for personal service
• • location in particular shopping areas, e.g. villages
• • convenience, e.g. extended opening hours.