3.3.3 Economies and diseconomies of scale

Question 1

Economies of scale

Answer 1

Economies of scale are the advantages of large scale production that enable a large business to produce at a lower average cost than a smaller business.
- As a result, the firm is able to experience increasing returns to scale where an increase in inputs by a certain percentage will lead to a greater percentage increase in output.

Question 2

Diseconomies of scale

Answer 2

Diseconomies of scale are the disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise.
- The firm experiences decreasing returns to scale, where output increases by a smaller percentage than inputs.

Question 3

Constant returns to scale *

Answer 3

Constant returns to scale is where firms increase inputs and receive an increase in output by the same percentage.

Question 4

Minimum efficient scale

Answer 4

The minimum efficient scale is the minimum level of output needed for a business to fully exploit economies of scale. It is the point where the LRAC curve first levels off and when constant returns to scale is first met.

Question 5

Internal economies of scale (The Fish Rides Motorcycles More)

Answer 5

An internal economy of scale is an advantage that a firm is able to enjoy because of a growth in the firm, independent of anything happening to other firms or the industry in general.
1) Technical economies
2) Financial economies
3) Risk bearing economies
4) Managerial economies
5) Marketing and purchasing economies

Question 6

Technical economies - internal economies of scale

Answer 6

Specialisation: Large firms will be able to appoint specialist workers and buy specialist machines which will be able to do their jobs more quickly and better than machines/workers which are not specialised.
Balances teams of machines: Large firms can afford to buy a number of every kind of machine for each stage of production. By combining these machines, they can ensure they run each machine at its optimal level. Smaller companies may only be able to afford one machine for each stage and if one stage of production runs faster than the other, machines will spend a long time turned off.
Increased dimensions: This relates to the fact that if you double the size of the walls you can increase the area by four times, or if you double the size of a container you increase the amount it can carry by more than double. This all occurs without doubling the cost.
Indivisibility of Capital: Some processes require huge items of machinery and investment that make it only possible for them to produce on a large scale.
Research and development: Often it is only large firms that can afford to carry out large scale research and development, which means they are able to gain a large advantage over their competitor.

Question 7

Financial economies - internal economies of scale

Answer 7

Large firms have greater security because they have more assets and are therefore less likely to be forced out of business overnight. As a result, it is easier for them to obtain finance and interest rates will be lower due to lower risk. This makes investment more accessible.

Question 8

Risk bearing economies - internal economies of scale

Answer 8

Large companies are able to operate in a range of different markets, producing different products which means that if one area of business fails, their whole business will not collapse.

Question 9

Managerial economies - internal economies of scale

Answer 9

Large companies can afford to appoint specialist managers in every field, who are specialised and so have greater knowledge and are able to do their job better. Staff represent an indivisibility and so small firms cannot employ specialist staff.

Question 10

Marketing and purchasing economies - internal economies of scale

Answer 10

Buying in bulk: Large firms are able to buy in large numbers so may be able to buy their raw materials at a cheaper price than competitors.
Specialisation: Like other areas, businesses can afford to take on specialist buyers and sellers who could be more efficient due to the extra time and knowledge.
Distribution: Large firms are able to enjoy preferential rates from transport companies because they offer the company a lot of businesses. They will be transporting in large batches which means that they will be able to transport in full, large transporters which are cheaper per item than half-full or smaller transporters.
Large businesses can also establish regional distribution centres which enables them to reduce transport costs by using large transporters over long distances, storing goods in the distribution centre and using smaller transport to take stock to individual shops.

Question 11

External economies of scale

Answer 11

An external economy of scale is an advantage which arises from the growth of the industry within which the firm operates, independent to the firm itself. These cause the LRAC curve to shift downwards.
1) Labour
2) Support services

Question 12

Labour - external economies of scale

Answer 12

• Businesses established in an area with other successful firms from the same industry find that labour tends to come to that area if they want a job in that industry, for example Silicon Valley. This reduces the cost and time take to recruit.
• Another advantage for large industries is that local education and training providers are more likely to develop courses to prepare people to take up jobs in these businesses.
• Firms will be able to hire staff who have been trained by other businesses, which is cheaper and more efficient for the firm than training the workers themselves.

Question 13

Support services - external economies of scale

Answer 13

• Businesses who provide products or services for large businesses will naturally move to the area where those businesses are based, which reduces transport cost/time delays for the business.

Question 14

Diseconomies of scale (W Girls Choose Pink Mallows)

Answer 14

1) Workers
2) Geography
3) Change
4) Prices of materials
5) Management

Question 15

Workers - diseconomies of scale

Answer 15

• In a large business, people can think their efforts go unnoticed and have less chance of promotion so lose motivation and work less hard. They can also lose their sense of belonging and have less personal commitment and identification with the business.

Question 16

Geography - diseconomies of scale

Answer 16

• A firm may have to transport finished products huge distances and firms may find it harder to control parts of the business which is miles away.

Question 17

Change - diseconomies of scale

Answer 17

• It takes much longer and is much more difficult for a large firm to respond to change.

Question 18

Prices of materials - diseconomies of scale

Answer 18

• As business grows so does their demand for raw materials and equipment. Although this can increase their bargaining power as they buy in bulk, an increase in demand can cause prices to rise and therefore increase production costs. This could also occur if the whole industry increases and so firms bid up prices.

Question 19

Management - diseconomies of scale

Answer 19

• Coordination and control: As a business grows, it will become progressively more difficult to coordinate and keep control of all the different parts of the business. Coordination of a multinational company producing different parts of a car around the world is much more difficult than coordinating and controlling the work of a local garage. This could lead to poorer quality to work and business decisions which don’t work well together.
• Communication: Within a large business communication can be slow and also can lose accuracy because of the distance and the number of people it has to be passed through.