ECONOMIES OF SCALE

15/10/17
1.6 Growth And Evolution
LO: Discuss the benefits of growth for a business.

All students will be able to define the terms

economy of scale
Most students will be able to calculate TC and AC
Some students will be able to comment on how
more than one economy of scale benefits a
business.
What is economies of scale?
Economies of scale are the cost advantages that a business obtains due
to expansion.

When economists are talking about economies of scale, they are

usually talking about internal economies of scale.

These are the advantages gained by an individual firm by increasing its

size i.e. having larger or more plants.
 Internal and External
economies of scale.
Internal economies of scale : lower long run average
costs (LRAC) resulting from a firm growing in size.

External economies of scale : lower long run average

costs (LRAC) resulting from an industry growing in size.
E.g.
Toyota noticing a decrease in LRAC- Internal
The whole car manufacturing industry noticing a
decrease in LRAC – External
Quick Task!
In your books

1. Differentiate between internal and

external EOS giving an example of a firm
and industry
 Total Costs
Total Costs = Variable Costs + Fixed Costs

TC= VC + FC
Variable costs vary as production varies e.g. raw materials,
wages

Fixed costs do not change as production varies e.g. rent, fixed

bills
Average Cost
AC = Total cost / quantity
produced

AC= TC / Q
Calculation!
◦ $
Rent 5000
Wages 4000
Wi-Fi Bill 600
Raw Materials 5000
Total production 7000units

Calculate the TC and AC.

Solution
FC= rent 5000 + Wifi Bill 600 = 5600
VC= Wages 4000 + Raw Materials 5000=
9000
TC= 5600 + 9000 = 14600

VC= 14600 / 7000units = $2.1 per unit

TOK
As Businesses grow, how do their methods of
knowing change? (knowing their customers, their
markets, the business environment)

Are these changes for the better or worse?

Types of Internal economies of scale.

1. Purchasing (buying) economies

2. Selling economies
3. Technical economies
4. Managerial economies
5. Financial economies
6. Marketing economies
7. Risk-bearing economies.
Food for thought…
Why are products that are bought in
multiples cheaper than a single item?
Purchasing (Buying) Economies.
These are the most known type. Large firms that buy
raw materials in bulk and place large orders for capital
equipment usually receive a discount.

They may receive a better treatment because the

suppliers will be anxious to keep such large customers.
 Supermart.ae
Per bar – 1.50fils Per bar – 0.88fils * prices compared
08/10/16

*3.50 / 4 = 0.88fils
3.50 / 40g = 9/ 165g =
9fils per gram 5fils per gram Supermart.ae
prices compared
08/10/16
 Jigsaw!
Each person will be given a number 1-5.

All the 1’s group together,

1-Technical 2’s etc. You must become
2-Managerial exports on your type of
economy and diseconomy
3-Financial of scale.
4-Marketing
Once every group is an
5-Risk Bearing expert we will form groups
of 1-5’s to share our
knowledge.
Check Point
All students will be able to define the term
economy of scale
Most students will be able to calculate TC
and AC
Some students will be able to comment on
how more than one economy of scale
benefits a business.
 Selling Economies.
Every part of marketing has a cost – particularly promotional methods such as

advertising and running a sales force. Many of these marketing costs are fixed

costs and so as a business gets larger, it is able to spread the cost of marketing

over a wider range of products and sales – cutting the average marketing cost

per unit.
 Managerial Economies.
As a firm grows, there is greater potential for managers

to specialize in particular tasks (e.g. marketing, human

resource management, finance).

Specialist managers are likely to be more efficient as they

possess a high level of expertise, experience and

qualifications compared to one person in a smaller firm

trying to perform all of these roles.

Financial economies
Many small businesses find it hard to obtain finance
and when they do obtain it, the cost of the finance is
often quite high.

This is because small businesses are perceived as

being riskier than larger businesses that have
developed a good track record.

Larger firms therefore find it easier to find potential

lenders and to raise money at lower interest rates.
Technical Economies.
Businesses with large-scale production can use more advanced
machinery (or use existing machinery more efficiently).

This may include using mass production techniques, which are a more
efficient form of production. A larger firm can also afford to invest more
in research and development.
Marketing economies.
A large firm can have marketing EOS. For example, a
business who wants a television advertisement to promote
the business, if the company has a large output they are
benefiting from spreading the fixed cost of promotion over
a larger level of output.

E.g. 50,000 / 800 = 62.50per unit

50,000 / 8000= 6.25per unit
Risk-bearing economies.
Larger firms produce a range of products. This enables them
to spread the risks of trading. If the profitability of one of
the products it produces falls, it can shift its resources to the
production of more profitable products.
Plenary
Identify a business you are interested in and apply
specific examples to each of the types of economies of
scale.

E.g. Apple
Growing larger meant that Apple could benefit from
managerial economies of scale, they now have a position
of chief design officer who specializes in design, that they
would not have been able to hire if they were a smaller
firm.
LO: Discuss diseconomies of
scale
All students will be able to define the term
diseconomy of scale
Most students will be able to calculate TC
and AC
Some students will be able to comment on
how more than one economy of scale
benefits a business.
 What is diseconomies of
scale?
•Diseconomies of scale are the disadvantages of being too large.

•A firm that increases its scale of operation to a point where it encounters rising
long term average costs is said to be experiencing internal diseconomies of
scale.

You are at full capacity and demand

for your product is increasing,
what can you do?
 Internal and external
diseconomies of scale.
Internal diseconomies of scale : higher long run average cost arising from a
firm growing too large.

External diseconomies of scale: higher long run average costs resulting from an
industry growing too large
Internal Diseconomies of
scale.
Growing beyond a certain output can cause a
firms average costs to rise. This is because the firm
may encounter a number of problems including
difficulties :-
controlling the firm.

communication problems.

poor industrial relations.

 Difficulty controlling the firm.
 It can be hard for those managing a large firm to

supervise everything that is happening in the business.

Management becomes more complex and meetings are

necessary quite often.

This can increase administrative costs and make the firm

slower in responding to changes in marketing conditions.

Communication problems.
Difficult to ensure that everyone is aware about their
duties in a large firm and available opportunities like
training etc.

The may not get a chance to exchange their views and

innovative ideas to the management team.
Poor industrial relations.
Higher risk for larger firms as there will be more conflicts
and diverse opinions.

Lack of motivation of workers, strikes will be seen at

certain situations in larger firms due to poor industrial
relations.
 External economies of scale.
A skilled labour workforce – A firm can recruit workers who have been trained by
other firms in the industry. Geographical areas can also have an effect on labour,
e.g. DIP- manufacturing, attracts skilled workers to the area.

A good reputation – An area can gain a reputation for high quality production.

Specialist suppliers of raw materials and capital goods – When an industry

becomes large enough, it can become worthwhile for other industries, called
subsidiary industries to set up for providing for the needs of the industry.
 External economies of scale.
Specialist services – Universities and colleges may run courses for workers in large
industries and banks and transport firms may provide services, specially designed
to meet the particular needs of firms in the industry.

Specialist markets – Some large industries have specialist selling places and
arrangements such as corn exchanges and insurance markets.

Improved infrastructure – The growth of an industry may encourage a govt and

private sector firms to provide better road links, electricity supplies, build new
airports and develop dock facilities.
 External Diseconomies of
scale.
Just as a firm can grow too large, so can an industry.

Larger firms -> transportation increase -> congestion ->

increased journey time -> high transport cost -> reduced
workers productivity.

Growth of industry may increase competition for

resources, pushing up the price of key sites, capital
equipment and labour.
 Small vs Large Organisations

Not all businesses aim to be large. High-end

product and service businesses prefer to be close
to their markets and clients. Niche markets are an
example of this.
 Advantages of Business
Greater focus
sizes
Greater cachet (prestige)
Survival Greater motivation
Economies of Scale Competitive advantage
Higher status Less competition
Market leader status Increased customer
relations
Increased market share
LARGE SMALL
Task
You own a sole trader enterprise. You are a hairdresser by trade and
have a large pool of loyal clients, each week you are fully booked at
least a month in advance.

Should you make the move to expand? Evaluate this decision.