Economies and diseconomies of scale

Economies of scale occurs when the average costs of a firm decrease due to increased output.
On the other hand, diseconomies of scale occur when the average costs of a firm increase due
to increased output. This can be shown on the diagram below:

The minimum efficient scale is the point at which the curve first stops falling and levels off. This
is the minimum output required by the firm to full exploit economies of scale. Both of the red
lines represent all the output values in which the firm is fully exploiting economies of scale,
before diseconomies of scale set in.

 Internal economies of scale

This is when just the individual firm benefits of increased output. The internal economies of
scale are as follow:

Financial

One of the benefits of being big is that a big firm is more likely to get approved to take out a
bank loan and at a lower rate of interest than smaller firms. The main reason for this is due to
the fact that larger firms are often associated as being more reputable and therefore less risky.
This means that banks will be happy to lend a large firm a loan and do so at a lower interest
rate, as they do not need to charge higher rates of interest to make up for the higher risk
investment.

 Technical

A large firm is able to afford specialist machinery that smaller firms are unable to. This specialist
machinery leads to a decrease in the firm’s average costs, thus increasing their competitiveness
within the market. In addition to this, larger firms can afford to split their production process
into different tasks through the division of labour. This is often seen in the automotive industry
and is known to increase the efficiency of production. Furthermore, larger firms are also able to
benefit through the law of increased dimensions. This occurs when doubling the height and
width of a lorry or warehouse etc leads to a more than proportionate increase in the cubic
storage space available. The benefit of this applies mainly to large firms within transport and
distribution industries.

Managerial

Larger firms are able to split themselves up in to different departments where they can afford to
employ specialist mangers e.g. human resources, finance etc. As each of these managers are
specialized in their department, efficiency and productivity within the firm increases.

 Marketing

The larger the firm, the larger the output produced. As a result of this, marketing costs are
spread over a larger output. Therefore the firm is able to spend more money on marketing as
the marketing cost per good/service or customer is cheaper than that of a smaller firm. In
addition to this, as a large firm is able to spend more money on advertisement, they are also
likely to have more leverage over advertisement companies in terms of price than that of a
smaller firm.

Purchasing

Large firms are likely to be able to purchase goods or raw materials at a lower price than smaller
firms. This is due to discounts received by large firms when they by in bulk.

Internal diseconomies of scale

Some firms become too large and their average costs begin to rise. They are then said to
experience diseconomies of scale.