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3.3.3 Economies and diseconomies of scale

Economies and diseconomies of scale 

Economies of scale occur when an increase in a firm's scale of production leads to a lower LR average cost. 

 Diseconomies of scale occur when an increase in a firm's scale of production leads to a higher LR average cost. 

 Constant returns to scale occur when LR average cost remains constant with an increase in output 
i.e output and costs rise at the same rate. 
Found at the minimum of the LRAC. 

Types of economies and diseconomies of scale 

External economies of scale - economies of scale that arise from the expansion of the industry in which a firm is operating. 

i.e as a sector expands, firms are able to choose from a larger pool of skilled workers, and may be able to forgo expenses on training, advertising, etc. 

Internal economies of scale - processes that a firm can benefit from as they increase their own scale of production in order to reduce their LRAC. 

These can be divided into technical and non-technical. 

Technical 

Division of labour 
Only large firms employ enough workers to allow for specialisation to occur. Specialisation and the division of labour allows for higher productivity as each worker becomes better at their particular task. 
Transition times are also reduced, further increasing productivity. 
Costs go down as a result. 

Economies of linked processes 
Stocks/spare parts/support services (marketing/legal divisions) all increase at a slower rate than output. 
So they make up a proportionally smaller amount of firms' costs as they expand. 

Indivisibilities of capital 
Small firms under-employ their machinery as it tends to be produced with a higher capacity than they need. As firms expand they don't have to increase expenditure on capital stock as a result. 
e.g photocopiers at small school aren't going to be used all the time. 

Economies of increased dimension 
The surface area increases at a slower rate than volume. As a result larger boxes can be made to hold more stuff at a cheaper per unit cost in terms of volume. 
i.e a larger ship can transport proportionally more than a smaller ship, same with storage, packaging, etc. 


Non-technical

Commercial
Raw materials that are bought at a larger scale will often be sold at a cheaper rate per unit. 
i.e buying in bulk 

This is because suppliers gain economies of scale themselves from larger orders, lowering their AC and allowing for the cheaper price to be charged per unit. 
Also, larger firms have monopsony power over suppliers so are able to have more control over the price of those supplies. 

Financial
Larger companies can acquire finance at a cheaper rate per £ borrowed. 

Because they are deemed less 'risky' by banks. They are more likely to have fixed assets to act as collateral for the loan and are less prone to a rapid exit from the industry. 

Risk-bearing
Larger firms tend to produce for national if not international markets, so are less prone to a downturn in any one market. 

Managerial 
As the size of a company grows, the management team may not have to grow as rapidly as the overall firm as a large firm can be managed more efficiently (up to a certain point). At a certain limit the organisation becomes so complex that diseconomies of scale kick in. 


Economies of scope 

These occur when AC falls as a firm increases output across a range of different products. 

This is due to the firm being able to share certain operations across divisions. 
e.g same finance/accounting division can be used for all products. 

e.g Nestle - conglomerate integration 

Minimum efficient scale 

The level of output at which LRAC stops falling as output increases. 

This is the point at which productive efficiency occurs. 



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