Economies and Diseconomies of Scale CLARITY

The Diagram OUTPUT Unit Costs Economies of scale: Unit costs fall Diseconomies of Scale: Unit Costs increase Optimum level of output

What are Economies of Scale A fall in the unit costs involved in generating an output through growth – Purchasing economies of scale – Marketing economies of scale – Technical economies of scale – Financial economies of scale – Risk bearing economies of scale

Discussion How can an increase in size generate a drop in costs?

External economies of scale Economies of scale which benefit the INDUSTRY but are not under the control of the FIRM –E–External economies of scale arise from firms in related industries operating in a concentrated geographical area; suppliers of services and raw materials to all these firms can do so more efficiently. Infrastructure such as roads and sophisticated telecommunications are easier to justify. There is also likely to be a growing local pool of skilled labour as other local firms in the industry also train workers. This gives a larger and more flexible labour market in the area.

Diseconomies of Scale These are inefficiencies that can creep in when a firm operates on a larger scale.The main diseconomies of scale are: –L–Lack of motivation – in larger firms, workers can feel that they are not appreciated or valued as individuals - see Mayo and Herzberg. It can be more difficult for managers in larger firms to develop the right kind of relationship with workers. If motivation falls, productivity may fall leading to inefficiencies. –P–Poor communication – it can be easier for smaller firms to communicate with all staff in a personal way. In larger firms, there is likely to be greater use written of notes rather than by explaining personally. Messages can remain unread or misunderstood and staff are not properly informed. –C–Co-ordination – a very large business takes a lot of organising, leading to an increase in meetings and planning to ensure that all staff know what they are supposed to be doing. New layers of management may be required, adding to costs and creating further links in the chain of communication.

Discussion How is it possible for a firm to see an increase in unit costs as a result of increasing size? At what point is the output level ‘best’?