The Indian Institute of Planning and Management

Economies of Scale The advantages of large scale production that result in lower unit (average) costs (cost per unit) AC = TC / Q Economies of Scale spreads total costs over a greater range of outputThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of ScaleUnit Cost Scale A 82p Scale B 54p LRAC

MES

Output

The Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale Internal advantages that arise as a result of the growth of the firm Technical Commercial Financial Managerial Risk BearingThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale Internal: Technical Specialisation large organisations can employ specialised labour Indivisibility of plant machines cant be broken down to do smaller jobs! Principle of multiples firms using more than one machine of different capacities more efficient Increased dimensions bigger containers can reduce average costThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

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.The Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale Principle of Multiples: Some production processes need more than one machine Different capacities May need more than one machine to be fully efficient

The Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale Principle of Multiples: e.g.Machine A Machine B Machine C Machine D Capacity = Capacity = Capacity = Capacity = 10 per hour 20 per hour 15 per hour 30 per hourCost = 100 per machine Cost = 50 per machine Cost = 150 per machine Cost = 200 per machine

Company A = 1 of each machine, output per hour = 10 Total Cost = 500 AC = 50 per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D output per hour = 60 Total Cost = 1750 AC = 29.16 per unitThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of ScaleIncreased Dimensions: e.g. Transport container = Volume of 20m32m 5m

Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 2m 600 per journey AC = 30m3 Total Cost = 1800 per journey AC = 11.25m3

4m 4m 10m

Transport Container 2 = Volume 160m3The Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale Commercial Large firms can negotiate favourable prices as a result of buying in bulk Large firms may have advantages in keeping prices higher because of their market powerThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

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 financeThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale

ManagerialUse of specialists accountants, marketing, lawyers, production, human resources, etc.

The Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale

Risk BearingDiversification Markets across regions/countries Product ranges R&D

The Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Diseconomies of Scale The disadvantages of large scale production 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 controlThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Economies of Scale External Economies of Scale the advantages firms can gain as a result of the growth of the industry normally associated with a particular area Supply of skilled labour Reputation Local knowledge and skills Infrastructure Training facilitiesThe Indian Institute of Planning and Management, New Delhi

The Indian Institute of Planning and Management

Assignment For each of the five main sources of internal economies of scale (technical, commercial, financial, managerial, risk bearing) think of an example of how these could apply to the electronics/electrical good industry and explain your reasoning. What disadvantages might there be for consumers of firms experiencing economies of scale? Why might economies of scale be inappropriate, undesirable or inaccessible for some firms?

The Indian Institute of Planning and Management, New Delhi