EC2 Economics

Chapter 17: Economies and Diseconomies of Scale

Would I get a better deal (cost per unit = average cost) if I bought
all of the cans on the left or just one of the cans on the right?
Why?

BULK BUYING
By the end
Chapter of the lesson,
17 Microeconomics: you
Economies and should
Diseconomies understand:
of Scale

a) Economies of scale:
• definition of economies of scale
• definition of internal economies of scale
• types of internal economies of scale:
o purchasing (bulk buying)
o marketing
o technical
o financial
o managerial
o risk bearing.
• definition of external economies of scale
• types of external economies of scale:
o skilled labour
o infrastructure
o access to suppliers
o similar businesses in area.

b) Diseconomies of scale:
• definition of diseconomies of scale
• types of diseconomies of scale:
o bureaucracy
o communication problems
o lack of control
o distance between top management and workers at bottom of the organisation
• the use of long run average cost (LRAC) curve
Key terms: Matching

1. scale A. falling average costs due to expansion

2. diseconomies of B. cost benefits that an individual firm can enjoy
when it expands
scale
C. to organise people or things so that they work
3. economies of scale together well
4. internal economies D. size of a business
of scale E. rising average costs when a firm becomes too
5. bulk buying big
6. external F. buying goods in large quantities, which is usually
cheaper than buying in small quantities
economies of scale G. cost benefits that all firms in an industry can
7. bureaucracy enjoy when the industry expands
8. coordinate H. system of administration that uses a large
number of departments and officials
Key terms: Answers
1. Economies of scale A. falling average costs due to expansion

2. Internal economies of B. cost benefits that an individual firm can enjoy

scale when it expands

3. Coordinate C. to organise people or things so that they work

together well
4. Scale D. size of a business

5. Diseconomies of scale E. rising average costs when a firm becomes too big
F. buying goods in large quantities, which is usually
6. Bulk buying
cheaper than buying in small quantities
7. External economies of G. cost benefits that all firms in an industry can
scale enjoy when the industry expands
H. system of administration that uses a large number
8. bureaucracy of departments and officials
CHAPTER 16 - ECONOMIES & DISECONOMIES OF SCALE

Average costs

= Total Costs / Quantity

Produced

Most Efficient
Point
Part 1: Internal economies of scale
 Internal Economies of Scale

Definition: Cost benefits that an individual firm can enjoy

when it expands.

• The more a company produces, the cheaper it gets.

• This gives large businesses an advantage over small
businesses.
• There are six internal economies that large businesses enjoy.
Name 6 internal ● purchasing economies
economies of scale ● marketing economies
● technical economies
that give a growing
● financial economies
or large firm an
● managerial economies
advantage over ● risk-bearing economies
smaller firms.
 Six Internal Economics of Scale

1. Purchasing Economies
Would I get a better deal (cheaper cost per item) if I bought all of the
cans on the left or just one of the cans on the right? Why?
 Six Internal Economics of Scale

1. Purchasing Economies
Bulk buying = buying raw material in large quantities, which is usually
cheaper than buying in smaller quantities.

Think of a time when you were able to get a discount when you bought
more than one.
 Six Internal Economics of Scale

2. Marketing Economies
Marketing: advertising, promotions, discounts (cost for the company), delivery truck
Spreading a marketing budget (costs) over a large amount of products
and/or services (TV ad costs can be spread across many units)
Large Firm Small Firm
Units sold 1,000,000 100,000

A. Marketing budget $1,000,000 $100,000

($1 per unit)
B. Marketing budget $0.30 per unit (cost) $3.00 per unit (cost)
($300K for each)
Six Internal Economics of Scale

2. Marketing Economies
The top advertising budgets for 2016 are as follows:

Pampers - $8.3bn (Ranked 50th most valuable brand)

Gillette - $8.3bn (28th)
L’Oreal - $8.2bn (34th) Small companies that sell much
Chevrolet - $5.1bn (59th) fewer units can not compete
Louis Vuitton - $4.4bn (19th) with billion dollar budgets only
Ford - $4.3bn (35th)
Coca-Cola - $4bn (4th)
related to advertising (getting
Amazon - $3.8bn (12th) your product known).
Sony - $3.7bn (76th)
AT&T - $3.6bn (13th)
Lexus - $3.6bn (63rd)
Toyota - $3.6bn (6th)
Samsung - $3.3bn (11th)

https://www.businesschief.eu/marketing/top-20-companies-biggest-advertising-budget
 Six Internal Economics of Scale

3. Technical Economies
• Businesses with large-scale production (mass production) can use more expensive, advanced
technology
• Companies with large production (units) can spread the costs of the expensive equipment over more
units than smaller companies
• For example, a supermarket chain such as Tesco or Sainsbury's can invest in technology that
improves stock control. A small neighbourhood grocery store can not afford the expensive equipment.

Equipment Cost ($1M) Large Firm Small Firm

Units sold 1,000,000 100,000

Cost per unit $1 per unit $10 per unit

 Six Internal Economics of Scale

4. Financial Economies
• Smaller companies have more trouble obtaining a loan from a bank than large companies (more risk).
• A bank will loans Google money much faster than XYZ company. If they do make a loan, they will
charge more interest for the risk (10% vs. 2%, for example).
• This adds to the costs of a small firm and makes the costs for the larger firm cheaper.

$1,000,000 bank loan Large Firm Small Firm

Interest 2% 10%

Interest payment (cost) $20,000 $100,000

 Six Internal Economics of Scale

5. Managerial Economies
Specialists, such as accountants, ca be employed to improve efficiency. Most small business owners
have to do many of jobs (including ones where they aren't experienced). This is inefficient. Once a
company gets a certain size, they can afford to hire professionals. This helps efficiency.

VS.
 Six Internal Economics of Scale

6. Risk Bearing Economies

• Wide range of products and more markets to reduce business risks

PRODUCT RANGE GEORGRAPHIC MARKETS

Case Study: IKEA

pages 127-128
 A. technical economies of
scale = specialisation of
specialist workers (DOL) =
Discuss how IKEA is better efficiency = lower
costs of production
exploiting or taking
advantage of (a)
technical economies A. risk-bearing economies of
scale = wider range of
of scale and (b) risk-
products and new products
bearing economies of = if one product/market
scale. isn't doing well can be
offset by another
product/market
Internal economies of scale: matching
1. purchasing A. bank loans with lower interest rates
economies B. able to lower average cost of
2. marketing advertising or promotion
economies C. able to afford specialist workers who
3. technical are more efficient
economies D. able to test new products as well as
4. financial produce a wider range of products
economies E. more investment into machinery and
5. managerial more usage of specialised equipment
economies F. buy cheaper materials by buying in bulk
6. risk-bearing at discount rates
economies
Discussion: Which internal economies of scale below do you think Migros
benefits from the most? Explain how and why.
1. purchasing F. buy cheaper materials by buying in bulk
economies at discount rates
2. marketing B. able to lower average cost of advertising
economies or promotion
3. technical E. more investment into machinery and
economies more usage of specialised equipment
4. financial A. bank loans with lower interest rates
economies C. able to afford specialist workers who
5. managerial are more efficient
economies D. able to test new products as well as
6. risk-bearing produce a wider range of products
economies
Part 2: External economies of scale
What is the difference between internal economies of
scale and external economies of scale? 126 and 128

1. internal = 1 firm
a. Migros
2.external = 1 industry
(multiple firms)
a. supermarket industry
SWISS WATCHMAKING TOWN

Chaux-de-Fonds / Le Locle, Watchmaking Town Planning

The site of La Chaux-de-Fonds / Le Locle watchmaking town-planning consists of

two towns situated close to one another in a remote environment in the Swiss Jura
mountains, on land ill-suited to farming. Their planning and buildings reflect
watchmakers’ need of rational organization. Planned in the early 19th century, after
extensive fires, the towns owed their existence to this single industry. Their
layout along an open-ended scheme of parallel strips on which residential housing
and workshops are intermingled reflects the needs of the local watchmaking culture
that dates to the 17th century and is still alive today. The site presents outstanding
examples of mono-industrial manufacturing-towns which are well preserved and
still active. The urban planning of both towns has accommodated the transition
from the artisanal production of a cottage industry to the more concentrated factory
production of the late 19th and 20th centuries. The town of La Chaux-de-Fonds
was described by Karl Marx as a “huge factory-town” in Das Kapital where he
analyzed the division of labour in the watchmaking industry of the Jura.
Formula One
● Britain has a history of providing a base for some of the most successful
teams in Formula One. McLaren are based in Woking but Renault, Honda,
Williams and Red Bull are all clustered in the East Midlands. Partly
this is an accident of history - namely the availability of disused airfields
after the war.
● The cluster of F1 teams is a good example of the external economies
of scale that can be generated when a group of producers develop and
expand in a relatively small geographical area.
● Most of the teams currently racing are based in the UK, along with their
R&D operations. A whole network of industries, such as component
suppliers, engineering and design firms, have sprung up in Britain,
mostly in central England, to serve the sport both here and abroad. F1
also helps to support a far larger motorsport industry in the UK, for
example rally car racing and all its associated industries.
● Estimates of the total number of jobs dependent on motorsport in the
UK vary between 45,000 and 110,000.
Revision: Name the 4 ● skilled labour
external economies ● infrastructure
of scale that give a ● access to suppliers
growing or large firm ● similar businesses in
an advantage over the same area
smaller firms.
For each of the following
slides, brainstorm as many
examples as possible in
relation to Formula One.
 ● lower training
costs
Explain how ● Explanation: more
skilled labour vocational or
could benefit colleges providing
an entire required courses
to match the
industry. industry
 Explain how
infrastructure
● roads, railways,
could benefit ports designed
an entire to help one
industry. industry
 Explain how ● established
access to industry
suppliers could encourages
benefit an suppliers to set
up nearby =
entire
competitive
industry. market
Explain how an
industry ● cooperate and
benefits when share research
similar firms and development
costs
are close
together.
Revision: Name 4 reasons for external economies of scale.

1. skilled labour
2. infrastructure (roads, railways,
ports and buildings)
3. access to suppliers
4. similar businesses in the area
Part 3: Diseconomies of scale
What is meant by ● rising average costs
diseconomies of
when a firm
scale?
becomes too big
 Look at your diagram showing
economies of scale
average cost: 0 to 45
outputs (000s): 0 to 140

average 40 25 15 10 12.50 25 37
cost

output 10 20 40 70 90 120 135

(000s)
More than
70,000 units
 ● bureaucracy
Name the 4 ● communication problems
diseconomies of ● lack of control
scale. ● distance between senior
staff and shop floor
workers
 ● too many
resources for
Explain how administration
● too much
bureaucracy
paperwork slows
can affect down output and
large firms. more difficult to
make decisions
 ● more workers
● different
Explain how cultures and
languages
communication
● different time
problems can zones
affect a large ● = more difficult
firm. to organise
 Explain how a ● difficult to
lack of control coordinate
● more supervision
can affect a
● = more costs
large firm.
 ● too many layers of
management
Explain how ● staff at the top
unaware of the needs
office space of the staff at the
and distance bottom
● = lack of
can affect a understanding
large firm.
Draw a graph showing average costs, economies of
scale and diseconomies of scale.
Case Study: Volkswagen

pages 129-130
● 9-mark exam-style question
● 10 minutes
● assess ...
● explain both sides: pros and cons; yes or no
● no final evaluation or conclusion needed
 ● Yes - higher costs of
production = fines for defeat
device resulting from relying
more on bureaucracy and a lack
of control
Assess whether VW ● No - benefit from internal and
has experienced external economies of scale,

diseconomies of scale e.g. purchasing, marketing,

technical, financial and risk-
in its organisation. bearing economies as well as
infrastructure and skilled
labour = lower costs of
production
● DON’T FORGET TO ADD
DATA AND CONTEXT
Revision: Name 6 ● purchasing economies
internal economies of ● marketing economies
● technical economies
scale that give a
● financial economies
growing or large firm
● managerial economies
an advantage over ● risk-bearing economies
smaller firms.
Revision: Name 4 ● skilled labour
external economies ● infrastructure
of scale that give a ● access to suppliers
growing or large firm ● similar businesses in
an advantage over the same area
smaller firms.
 ● bureaucracy
Revision: Name 4 ● communication problems
diseconomies of ● lack of control
scale. ● distance between senior
staff and shop floor
workers