Economies of Scale

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 Marketing Financial Managerial Risk Bearing Purchasing

Economies of Scale Capital Land Labour Output TC AC Scale A 5 3 4 100 Scale 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’) of production facility What happens and why?

Economies of Scale Capital Land Labour Output TC AC Scale A 5 3 4 100 57 0.57 Scale B 10 6 8 300 164 0.54 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

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

Optimum efficient scale of production Costs AC Units