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The Indian Institute of Planning and Management

The Indian Institute of Planning and Management, New Delhi

Economies of Scale

The advantages of large scaleproduction that result in lower unit

(average) costs (cost per unit) AC = TC / Q

Economies of Scale spreads total

costs over a greater range ofoutput

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Economies of Scale

Unit Cost

Output

Scale A

Scale B

LRAC

MES

82p

54p

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The Indian Institute of Planning and Management, New Delhi

Economies of Scale

Internal advantages that arise asa result of the growth of the firm

Technical

Commercial

Financial

ManagerialRisk Bearing

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Economies of Scale

Internal: Technical

Specialisation large organisations can

employ specialised labour Indivisibility of plantmachines cant be

broken down to do smaller jobs!

Principle of multiples firms using more

than one machine of different capacitiesmore efficient

Increased dimensions bigger containerscan reduce average cost

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The Indian Institute of Planning and Management, New Delhi

Economies of Scale

Indivisibility of Plant:

Not viable to produce products like

oil, chemicals on small scale need large amounts of capital

Agriculture machinery

appropriate for large scale work combines, etc.

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The Indian Institute of Planning and Management, New Delhi

Economies of Scale

Principle of Multiples:

Some production processes need

more than one machine

Different capacities

May need more than one machineto be fully efficient

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Economies of Scale Principle of Multiples: e.g.

Machine A Machine B Machine C Machine D

Capacity =

10 per hour

Capacity =

20 per hour

Capacity =

15 per hour

Capacity =

30 per hourCost = 100per machine

Cost = 50per machine

Cost = 150per machine

Cost = 200

per machine

Company A = 1 of each machine, output per hour = 10

Total Cost = 500AC = 50 per unitCompany B = 6 x A, 3 x B, 4 x C, 2 x D output per hour = 60Total Cost = 1750AC = 29.16 per unit

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Economies of ScaleIncreased Dimensions: e.g.

5m

2m

2m

Transport container = Volume of 20m3

Total Cost: Construction, driver, fuel,maintenance, insurance, road tax =600 per journey

AC = 30m3

4m

10m

4m

Transport Container 2 = Volume 160m3

Total Cost = 1800 perjourneyAC = 11.25m3

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Economies of Scale

Commercial

Large firms can negotiate

favourable prices as a result ofbuying in bulk

Large firms may have advantages

in keeping prices higher because oftheir market power

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Economies of Scale

Financial

Large firms able to negotiate

cheaper finance deals Large firms able to be more

flexible about finance share

options, rights issues, etc. Large firms able to utilise skills of

merchant banks to arrange finance

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Economies of Scale

Managerial

Use of specialists

accountants, marketing,

lawyers, production, human

resources, etc.

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Economies of Scale

Risk BearingDiversification

Markets across regions/countries

Product ranges

R&D

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Diseconomies of Scale

The disadvantages of large scaleproduction that can lead to

increasing average costs Problems of management

Maintaining effective communication

Co-ordinating activities often across the

globe! De-motivation and alienation of staff

Divorce of ownership and control

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Economies of Scale

External Economies of Scale theadvantages firms can gain as a result ofthe growth of the industry normallyassociated with a particular area

Supply of skilled labour

Reputation

Local knowledge and skills Infrastructure

Training facilities

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Assignment For each of the five main sources of internal

economies of scale (technical, commercial,financial, managerial, risk bearing) think ofan example of how these could apply to theelectronics/electrical good industry andexplain your reasoning.

What disadvantages might there be forconsumers of firms experiencing economiesof scale?

Why might economies of scale beinappropriate, undesirable or inaccessible forsome firms?