2. Why are most car factories large?
Why is Coca Cola able to spend huge sums
every year on high profile advertising around
What are the possible economies of scale
available to the main international
manufacturers of mobile phones?
3. Desire for economy
Desire for large profits
Desire for economic power and prestige
Desire for increase of demand
Desire for self defence in a competitive
4. Economies of scale are the cost advantages
that an enterprise obtains due to expansion.
It leads to reduction in unit costs as the scale
of operations increases.
5. This refers to an increase in the capacity of a
business. It could be achieved by
◦ Buying new machinery
◦ Building a bigger factory/ shop/ plane/ ship
◦ Merger & acquisitions
6. As quantity of
from Q to Q2, the
average cost of each
unit decreases from C
7. Economies of scale tend to occur in industries with
high capital costs in which those costs can be
distributed across a large number of units of
production (both in absolute
terms, and, especially, relative to the size of the
A common example is a factory
8. Internal Economies of Scale: They are
specific to individual firm.
External Economies of Scale: Advantages
that benefit the industry as a whole.
9. Internal economies of scale are a product of
how efficient a firm is at producing;
These are those economies of scale which a
firm has direct control over.
11. Labour Economies:
◦ Increased division of labour
◦ Large firms attract more efficient labour as it can
offer wide vertical mobility, promotion prospects
◦ Efficiency and increased productivity leads to lower
cost per unit of output
12. Technical Economies:
Refers to reduction in cost of manufacturing process
◦ Economies of superior technique
◦ Economies of increased dimension
◦ Economies of linked process
◦ Economies in power
◦ Economies of by-products
◦ Economies of continuation
13. Managerial Economies:
◦ Cost per unit of management falls as output
◦ Economies of buying (of raw materials) and selling
◦ Effective use of advertising/ promotion
14. Financial Economies:
◦ Greater reputation of large firms in the money
◦ Big firms perceived as less risky by investors
◦ Big firms can easily raise capital by issuing shares
15. Risk-Minimising Economies:
◦ By diversification of output
◦ By diversification of market
◦ By diversification of sources of supply as well as of
process of manufacturing
16. These are economies made outside the firm
as a result of its location, and occur when:
◦ A local skilled labour force is available.
◦ Specialist, and local back-up firms can supply
parts or services.
◦ An area has a good transportation network.
◦ An area has an excellent reputation for producing
a particular good. For example, Saskatchewan is
known for their wheat and grain production.
17. Economies of Localisation:
◦ Mutual benefit enjoyed by firms due to local factors
such as- skilled labour, better transport
facilities, stimulation of improvement etc..
◦ Easy arrangements for repair, maintenance and
special services required by the industries.
18. Economies of Information or Technical &
◦ Technical publication by one large firm accessible
to others, so the benefit is shared
Economies of Vertical Disintegration:
◦ Subsidiary industries specializing in certain areas
provide services to several big firms offering each
of them internal economy of scale
19. Economies of By-products:
◦ Large industry can make use of waste material for
20. • The advantages of large scale production
that result in lower unit (average) costs (cost
• Our Formula:
– AC = TC / Q
• AC=Average Cost
• TC=Total Cost
• Q= Quantity
• Economies of scale – spreads total costs
over a greater range of output
21. Capital Land Labour Output TC AC
Scale A 5 3 4 100
Scale B 10 6 8 300
• Assume each unit of capital = $5.00, Land = $8.00 and Labour =
• Calculate TC and then AC for the two different „scales‟ („sizes‟) of
• What happens and why?
22. Capital Land Labour Output TC AC
Scale A 5 3 4 100 112 $1.12
Scale B 10 6 8 300 212 $0.71
Doubling the scale of production (a rise of 100%) has led to an
increase in output of 200%
therefore cost of production per unit has fallen
Don‟t get confused between Total Cost and Average Cost
Overall „costs‟ will rise but unit costs can fall
23. • As with all things, as industries get bigger so does
the infrastructure and the problems associated with
economies of scale.
• There is a fine line between making money and
• This can result in:
– Internal Diseconomies of Scale
– External Diseconomies of Scale
24. Cobb Douglas production function , Q1=AL1αK1β
◦ L1 and K1 = initial quantities of labor and capital
◦ Q1 = initial level of output
Increase all input quantities by the same proportional amount λ
◦ Q2 = resulting volume of output
◦ Q2=A(λL1)α(λK1)β= λα+β AL1αK1β = λα+β Q1
If α+β>1, λα+β>λ and so Q2> λQ1 (increasing returns to scale )
If α+β=1, λα+β=λ and so Q2 =λQ1 (constant returns to scale )
If α+β<1, λα+β<λ and so Q2< λQ1 ( decreasing returns to scale )
25. Adam Smith –pin factory
27. Diseconomies of scale are the forces that
cause larger firms and governments to
produce goods and services at increased per-
unit costs. The concept is the opposite
of economies of scale.
28. Managerial inefficiency: As a firm grows and levels
of hierarchy increase the efficiency and
effectiveness of communication breaks down this
leads to increasing inefficiency and therefore
increasing average costs.
Labour inefficiency: With larger firms, it is harder to
satisfy and motivate workers. This means they do
not give of their best, and again as the firm grows
average output falls, and average costs increase
29. Breakdown of relationships with suppliers and buyers: When
the firm is small, there is often a direct relationship between
owner managers and customers or suppliers. As the firm
grows, these relationships are hard to maintain as the owner
manager finds his time is taken up with administration or
Competition for labour: More firms means increased demand
for labour, making the best workers harder to recruit and
Increasing employment costs: More firms means increased
demand pushing up the price of labour-wages
Traffic congestion: The firm grows, suppliers move in, the
area becomes an industrial centre, the roads are clogged with
vehicles making deliveries late.
30. Optimum Point
Point of inflection
Reversal of Phenomenon-
‟Economies of Scale‟
Not a counter argument but tracing
& understanding of trend reversal
Even magnitude of slope increases
at every „X axis value‟ in reverse
Optimum Point= limiting point
All is play on a „Number‟
Optimum Point=Point of inflection
31. • Economies+Diseconomies
• Economies of Scale
• 2 Points of Inflexion
• One Point of Inflexion
• Large and small firms can coexist in
• Single Large Firms Existence
the same industry
• Refers to the negative
• Applies to the upward slope, where
derivative of the cost curve at
diseconomies of scale due to
outputs smaller than M1
diminishing returns to management
, where economies of scale in
set in beyond M 2.
production have not yet been
32. Raises & Answers the Questions-
If size were a great advantage, the smaller companies would soon
lose the unequal race and disappear”.
Why is not all production carried on by one big firm?
Why/How do Large & Small Firms Co-exist?
Why are large firms so small? What stops firms from effortlessly
expanding into new businesses?
No business organisation in the United States has more than one
million employees1 or more than ten hierarchical levels
Why “R&D Is More Efficient in Small Companies” ???
33. The first two hypotheses test the
tautological statement that
diseconomies of scale and economies
of scale increase with firm size. The
last three hypotheses test how a firm‟s
performance is affected by the
diseconomies of scale, economies of
scale and moderating influences.
Example-Apex Corporation Case (OB)
Work; End Goals/Objectives; Re-
iterating hierarchies ,Products &
H5-Application of M-form organisation
and pursuit of high internal asset
Hypotheses were tested against a sample of the
784 largest manufacturing firms in the United
States in 1998
34. Williamson‟s theoretical framework and translates it into five
(1) Bureaucratic failure, in the form of atmospheric
consequences, bureaucratic insularity, incentive limits and
communication distortion, increases with firm size;
(2) Large firms exhibit economies of scale;
(3) Diseconomies of scale from bureaucratic failure have a
negative impact on firm performance;
(4) Economies of scale increase the relative profitability of large
firms over smaller firms; and
(5) Diseconomies of scale are moderated by two transaction
cost-related factors: organisation form and asset specificity.
35. Williamson’s framework, supporting Williamson’s proposed four main categories of bureaucratic
failure of large firms:
“Atmospheric consequences”: as organisations become larger there is increased staff specialisation.
As a result it becomes harder for an individual to understand where they fit in to the whole and
hence a feeling of greater alienation and overall less commitment to the broader organisational goals.
“Bureaucratic insularity”: as organisations increase in size, senior managers become individually
accountable to other staff and to stakeholders. They can therefore become progressively insulated
from reality and, with opportunism, will seek to maximise personal benefits at the expense of the
“Incentive limits of the employee relation”: due to the requirement for increasing specialisation
disaggregation of roles, incentive programs at larger organisations are often misaligned with the
“Communication distortion due to bounded rationality”: as an organisation gets larger and more
complex it becomes impossible for any one individual to understand every aspect of its operation.
Further expansion in size therefore requires hierarchies (such as reporting lines).
36. • Two moderating factors tend to offset diseconomies of scale:
organisation form and degree of integration.
• Both are central to transaction cost economics
The M-form allows most senior executives to focus on high level
issues rather than day-to-day operational details, making the whole
greater than the sum of its parts (p. 137). Thus, large firms organised
according to the M-form should perform better than similar U-form
DEGREE OF INTEGRATION
• Uncertainty- Business-cycle volatility or rapid technological
• Frequency of transactions
• Asset specificity-With high asset specificity, market transactions
become expensive. Asset specificity refers to
physical, human, site, or dedicated assets which have a specific use
and cannot easily be transferred
37. Cooper (1964) surprised business leaders and academics with
his article “R&D Is More Efficient in Small Companies”.
The key reasons:
(1) small firms are able to hire better people because they can
offer more tailored incentives;
(2) engineers in small firms are more cost-conscious; and
(3) internal communication and coordination is more effective in
Significance- Answers all H3 Factors !!