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 output
Economies of Scale• Internal – advantages that arise as a result of the growth of the firm ▫ Technical ▫ Commercial ▫ Financial ▫ Managerial ▫ Risk Bearing
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 facilities
Economies of Scale Capital Land Labour Output TC ACScale A 5 3 4 100Scale B 10 6 8 300•Assume each unit of capital = £5, Land = £8 and Labour = £2•Calculate TC and then AC for the two different ‘scales’ (‘sizes’) ofproduction facility•What happens and why?
Economies of Scale Capital Land Labour Output TC ACScale A 5 3 4 100 57 0.57Scale B 10 6 8 300 164 0.54•Doubling the scale of production (a rise of 100%) has ledto an increase in output of 200% - therefore cost ofproduction•PER UNIT has fallen•Don’t get confused between Total Cost and Average Cost•Overall ‘costs’ will rise but unit costs can fall•Why?
Economies of Scale• Internal: Technical ▫ Specialisation – large organisations can employ specialised labour ▫ Indivisibility of plant – machines can’t 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 cost
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
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 hour Cost = £100 Cost = £50 Cost = £150 Cost = £200 per machine per machine per machine per machineCompany A = 1 of each machine, output per hour = 10Total 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
Economies of ScaleIncreased Dimensions: e.g. Transport container = Volume of 20m3 Total Cost: Construction, driver, fuel, 2m maintenance, insurance, road tax = 2m £600 per journey 5m AC = £30m3 Total Cost = £1800 per journey AC = £11.25m34m 4m 10m Transport Container 2 = Volume 160m3
Economies of Scale• Managerial ▫ Use of specialists – accountants, marketing, lawyers, production, human resources, etc.
Economies of ScaleUnit Cost Scale A 82p Scale B 54p LRAC MES Output
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 control