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Economies of scale

Economies of scale The cost advantage that arises with increased output of a product.Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs; i.e. the greater the quantity of a good produced, the lower the per-unit fixed cost. because these costs are shared over a larger number of goods. Economies of scale may also reduce variable costs per unit because of operational efficiencies and synergies.

Internal and External economies of scale.Internal economies of scale :- lower long run average costs resulting from a firm growing in size.External economies of scale :- lower long run average costs resulting from an industry growing in size.

Types of Internal economies of scale.

Buying economiesSelling economiesManagerial economiesFinancial economiesTechnical economiesResearch and development economiesRisk-bearing economies.

Buying Economies.These are the best known type. Large firms that buy raw materials in bulk and place large orders for capital equipment usually receive a discount. This means that they have paid less for each item purchased. They may receive a better treatment because the suppliers will be anxious to keep such large customers.

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 economiesMany 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.

Research and development economies.A large firm can have a research and development department, since running such a department can reduce average costs by developing more efficient methods of production and raise total revenue by developing new products.

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.

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.

External economies of scale.A skilled labour workforce A firm can recruit workers who have been trained by other firms in the industry.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 ma 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. 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.