WHAT ARE ECONOMIES OF SCALE?

• In the long run, all costs are assumed to be variable.

• Internal economies of scale are the unit cost advantages from a
business expanding the scale of production in the long run.
• They arise from the benefits of increasing returns to scale. Large-
scale production often uses fewer inputs per unit of output.
• Lower average costs are an improvement in productive efficiency
and can give a business a competitive cost advantage.
• Economies of scale can lead to lower prices for consumers and
higher profits which is good news for shareholders.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 ECONOMIES OF SCALE

Retailers such as Amazon Economies of scale help

can benefit from many drive growth & profits in
internal economies of scale the global beer industry

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 INTERNAL AND EXTERNAL ECONOMIES OF SCALE

• Internal Economies of Scale: These arise from within the

firm itself as it expands its own operations in the long run.
They result from the firm's own actions and decisions.
• External Economies of Scale: These arise from factors
outside the firm, often related to the industry or the
business environment in which the firm operates. They are
shared by multiple firms within an industry or geographic
region.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 DIFFERENT TYPES OF INTERNAL ECONOMY OF SCALE

• Technical economies of scale

• Managerial economies of scale
• Purchasing economies of scale
• Financial economies of scale
• Risk-bearing economies of scale

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 TECHNICAL ECONOMIES OF SCALE

• Specialised Equipment: For example, a

manufacturer of computer chips may be
able to invest in cutting-edge
semiconductor equipment that allows
them to produce a larger quantity of chips
with high precision, resulting in lower
costs per chip.
• Automated Production: Automation Specialised Automated
reduces the need for manual labour, capital manufacturing
minimizing errors, and increasing the
speed of production.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 THE LAW OF INCREASED DIMENSIONS

• Law of increased dimensions (also known as

the container principle) This is linked to the
cubic law – doubling the height and width of a
tanker/building leads to a more than
proportionate increase in cubic capacity
• The application of this law opens the
possibility of big scale economies in
distribution and freight industries and in travel
and leisure sectors with the emergence of Warehouses Freight
super-cruisers. The law of increased
dimensions is important in energy sectors,
office rental and warehousing. It is significant
in long haul airlines and cruise-ships.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 MANAGERIAL ECONOMIES OF SCALE

• This is a form of division of labour where firms employ

specialists to supervise production systems
• Better management and increased investment in human
resources and the use of specialist equipment, such as
networked computers can improve communication, raise
productivity, and thereby reduce unit costs.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 FINANCIAL ECONOMIES OF SCALE

• Financial markets usually rate larger, more established firms to be

more credit worthy and have access to loans with favourable rates
of borrowing – they may borrow much more overall than a small
firm and pay a lower rate of interest (although the bank still
benefits because of the large amount borrowed)
• Smaller firms often pay higher interest rate on overdrafts and loans.
Whereas businesses listed on the stock market can normally raise
new financial capital more cheaply through the sale of equities to
the capital market.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 PURCHASING ECONOMIES OF SCALE

• A large firm can purchase factor inputs

in bulk at lower prices if it has
monopsony power – we can call these
purchasing economies. Bulk purchases

• Large food retailers have monopsony

power when purchasing their supplies
from farmers and wine growers and in
completing supply contracts from food
processing businesses. Negotiations
with suppliers

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 RISK-BEARING ECONOMIES OF SCALE

• Risk-bearing economies of scale can occur when larger businesses are

better equipped to manage certain types of risks more efficiently than
smaller ones.
• This advantage arises from their size, and from product and market
diversification to make their business more resilient.
• Example: Insurance companies diversify their risk exposure across a
wide range of policies and customers
• Example: Amazon has since diversified into e-commerce, cloud
computing (Amazon Web Services), digital streaming (Amazon Prime
Video), and much more!

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 Economies of Scale at Pure Gym

Pure Gym is the largest low-cost gym

operator in the UK, with over 300 gyms. Pure
Gym has grown rapidly opening over 100 new
gyms in the past five years. The company's
2021 annual report stated that its revenue
was £308 million, up 11% from 2020. The
company's operating profit was £40 million,
up 20% from 2020.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 GIVE ME 3…
Examples of internal economies of
scale at a business such as Pure Gym

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 GIVE ME 3…
Internal economies of scale at Pure Gym

1
Purchasing power: Can use their monopsony power to negotiate lower
prices from suppliers for things such as gym equipment, fitness gear, food
and cleaning supplies.

2
Spreading fixed costs over many customers: Pure Gym must pay rent,
utilities, and insurance regardless of how many members it has. As Pure
Gym grows, this lowers the average cost per member.

3 Financial economies: Pure Gym can negotiate lower rates with commercial
landlords, and (in theory) it can borrow money at lower interest rates.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 Number of Premier Inn hotels in the United Kingdom (UK) 2012-
2022
900
841
804 820 817
800 785
762
737
697
700 672
649

600

500

400

300

200

100

0
2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22

INTERNAL SCALE ECONOMIES

 GIVE ME 3…
Examples of economies of scale
that larger hotel chains in the UK
can benefit from.

INTERNAL SCALE ECONOMIES TUTOR2U.NET/ECONOMICS

 GIVE ME 3…
Examples of economies of scale that large hotel chains in the UK can benefit from

Bulk Purchasing - Larger hotel chains purchase supplies in bulk, such as linens,
1 toiletries, and food items. Their monopsony power means they can negotiate lower
prices and achieve cost savings not be possible for smaller “boutique” hotels.

Technology - Large hotel chains invest in centralized reservation systems, property

2 management systems, and other IT infrastructure. By standardizing their technology
across multiple locations, they can reduce costs and improve productive efficiency.
Marketing and Branding - Large hotel chains can leverage their brand recognition and
3 marketing budgets across multiple locations to drive demand and increase occupancy
rates. Marketing is a fixed cost – consider Premier Inn’s TV advertising campaigns.

INTERNAL SCALE ECONOMIES

 Average cost per night of selected large hotel chains in
the United Kingdom as of August 2022 (£s)

Travelodge 78
Premier Inn 89
Ibis Budget 90
easyHotel 110
Holiday Inn 112
Crowne Plaza 129
Novotel 142
Hyatt 154
Marriott 159
Radisson Blu 167
Hilton 188
0 20 40 60 80 100 120 140 160 180 200

INTERNAL SCALE ECONOMIES

 THE LONG RUN AVERAGE COST CURVE

• The long run average cost curve (LRAC) is drawn on the assumption of
their being an infinite number of plant sizes that a business can use
• If LRAC is falling when output is increasing, then the firm is experiencing
economies of scale.
• For example, a doubling of factor inputs might lead to a more than
doubling of output.
• Conversely, when LRAC eventually starts to rise then the firm
experiences diseconomies of scale
• If LRAC is constant, the firm is experiencing constant returns to scale

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 Cost &
Revenue

Long run MC1

average cost
AC1

MC2 AC2

Each set of short run cost

curves relates to a given scale
of production (which means a
given combination of labour
and capital)

Output
 Cost &
Revenue
Increased scale of production (in the long run)
Long run MC1
average cost
AC1

MC2 AC2

Each set of short run cost

curves relates to a given scale
of production (which means a
given combination of labour
and capital)

Output
 Cost &
Revenue
Increased scale of production (in the long run)

MC1

AC1
AC3
MC2 MC3

AC2

Output
 Cost &
Revenue
Increased scale of production (in the long run)

MC1

AC1
AC3
MC2 MC3

AC2

LRAC

Output
 Cost &
Revenue

Minimum efficient scale (MES) LRAC

Internal economies of scale Internal diseconomies of scale

Output
 LONG RUN AVERAGE COST CURVE (LRAC)
Average
Cost Internal
(Unit economies of
Cost) scale causes
LRAC to fall
Long Run
Lowest point on LRAC Average Cost
is the output of
productive efficiency

Rising LRAC – means

diseconomies of scale

0
Q1 Q2 Q3 Q4 Output

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 What economies of
scale might be
achieved by large-scale
beer manufacturers?

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 ECONOMIES OF SCALE IN BEER PRODUCTION

1. Bulk purchasing - By producing large volumes of beer, companies can negotiate better
prices with suppliers for raw materials, such as hops, barley, and yeast.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 ECONOMIES OF SCALE IN BEER PRODUCTION

1. Bulk purchasing - By producing large volumes of beer, companies can negotiate better
prices with suppliers for raw materials, such as hops, barley, and yeast.
2. Production efficiency – Large-scale beer producers can invest in the latest technology to
streamline the brewing process, improving productive efficiency and lowering LRAC

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 ECONOMIES OF SCALE IN BEER PRODUCTION

1. Bulk purchasing - By producing large volumes of beer, companies can negotiate better
prices with suppliers for raw materials, such as hops, barley, and yeast.
2. Production efficiency – Large-scale beer producers can invest in the latest technology to
streamline the brewing process, improving productive efficiency and lowering LRAC
3. Distribution and marketing - By operating on a global scale, these companies can
benefit from economies of scale in terms of distribution and marketing.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 ECONOMIES OF SCALE IN BEER PRODUCTION

1. Bulk purchasing - By producing large volumes of beer, companies can negotiate better
prices with suppliers for raw materials, such as hops, barley, and yeast.
2. Production efficiency – Large-scale beer producers can invest in the latest technology to
streamline the brewing process, improving productive efficiency and lowering LRAC
3. Distribution and marketing - By operating on a global scale, these companies can
benefit from economies of scale in terms of distribution and marketing.
4. Research and development - Large beer producers can invest in research and
development to create new products, improve production processes, and reduce costs.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS

 ECONOMIES OF SCALE IN BEER PRODUCTION

1. Bulk purchasing - By producing large volumes of beer, companies can negotiate better
prices with suppliers for raw materials, such as hops, barley, and yeast.
2. Production efficiency – Large-scale beer producers can invest in the latest technology to
streamline the brewing process, improving productive efficiency and lowering LRAC
3. Distribution and marketing - By operating on a global scale, these companies can
benefit from economies of scale in terms of distribution and marketing.
4. Research and development - Large beer producers can invest in research and
development to create new products, improve production processes, and reduce costs.
5. Diversification - Companies can spread their risks across different markets, reducing the
impact of economic downturns or fluctuations in demand for beer in any one region.

ECONOMIES OF SCALE TUTOR2U.NET/ECONOMICS