AS Economics and Business Economies and Diseconomies of Scale Unit 2b By Mrs Hilton for revisionstation

Lesson Objectives To be able to discuss economies and diseconomies of scale To be able to discuss average costs To be able to discuss minimum efficient scale

Starter Did you ever buy lots of something because it was cheaper in bulk?

Economies of Scale The idea that as a business grows in size it will be able to gain competitive advantage in a number of ways: – By having more funds to buy stock, so being able to get better deals by buying in bulk – By having more power – By having more funds to pay for specialist staff – By having a better reputation so banks are more willing to lend We call this economies of scale

Give me the theory then.. Economies of scale (can we say EOS for short) occur when unit costs or average costs fall as a result as an increase in the level of output of the business. The more they make the cheaper it gets per item. ANY Eos question should be about how getting bigger means a firm can lower its average costs. They are like shoes – you need both to be comfortable.

Video on economies of scale

Why is EOS a good thing then? Can lead to: – Higher profit margins (as it costs less per item to make your product, you will have more profit in your pocket). – More funds for investment or even for giving shareholders higher dividends – means it will be easier to attract investment in the future

EOS categories

Bulk-buying / purchasing economies As businesses grow they need to order larger quantities of production inputs. As the order value increases, a business obtains more bargaining power with suppliers. It may be able to obtain discounts and lower prices for the raw materials.

Technical economies of scale Businesses with large-scale production can use more advanced machinery (or use existing machinery more efficiently). This may include using mass production techniques, which are a more efficient form of production. Fixed costs of purchasing machinery spread over higher levels of output. A larger firm can also afford to invest more in research and development.

Specialisation / managerial Greater potential for managers to specialise in particular tasks E.g. Employing a full time accountant In small firms the owners have to make lots of decisions, some he/she have little knowledge of. And so quality of decision making could be better in a larger firm.

Financial economies of scale Small businesses find it hard to obtain finance or the cost of the finance is often quite high. Small businesses are perceived as being riskier than larger businesses that have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at lower interest rates.

Marketing economies of scale Every part of marketing has a cost. As a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales – cutting the average marketing cost per unit.

Risk bearing Bigger companies can spread their risk by investing in more products and more markets This is called diversification

Overview Type of Economies of ScaleExplanation Financial Economies of Scale Large firms can benefit from cheaper loans and wider sources of cheap finance (investment from shareholders) Marketing Economies of Scale The advantages that large firms get in relation to buying and selling. Large firms can attract specialist buyers who don’t waste money buying stock that will not sell. They also have specialist sellers/marketing staff who ensure that goods will sell. Big firms benefit significantly from being able to “buy in bulk” Technical Economies of Scale These are the advantages that large firms have when it comes to the production process. Large firms can employ specialist labour and capital which stimulates productivity and reduces average costs Managerial Economies of Scale Large firms have the money/resources to attract the most productive/efficient/specialist managers who make the most effective business decisions and increase efficiency over time Risk- Bearing Economies of Scale Large firms benefit from having wider, more diversified product range. This means that they are better able to withstand the risk of a fall in demand for one good or service

Diseconomies of scale (DEOS)

Video on diseconomies of scale

Give me more theory then As the level of output of a firm increases the costs increase (DEOS) or oh no a graph This is an average cost curve. You don’t have to draw it but it may help you understand DEOS

Categories of DEOS

Lack of motivation Workers in large companies may feel demotivated – with little say in their working life This can lead to powerlessness and alienation Means increased absenteeism and lateness – Reduction in productivity – Lower output per worker – Means increased unit costs

Lack of communication As the size of the workforce increases there will be less face-to-face communication Takes a long time for messages to get through as there are many layers of management Less effective communication – Means mistakes made – Means more wastage – Therefore higher average unit costs

Lack of co-ordination As a company grows and takes on new staff, makes new products buys new premises all of this needs to be coordinated All resources need to be controlled so that operations can run smoothly Workers may need monitoring which can add to costs May need more managers which increases average cost per unit

Minimum efficient scale This is the most efficient point of production Bottom of the average cost curve

Sample question 1 The ability of a business such as housebuilder Barratt Homes to use its larger size to negotiate better terms with its suppliers of raw materials is an example of A diseconomies of scale. B technical economies of scale. C marketing economies of scale. D purchasing economies of scale.

Answer question 1 Answer D Purchasing economies of scale Economies of scale occur when the average cost per unit falls as output increases (1 mark) Purchasing economies occur when businesses are buying large enough quantities to be charged a lower price per unit (1 mark) either because unit supplier costs are reduced (1 mark) or because the buyer has market power/monopsony power (1 mark).e.g. cheaper bricks for Barratt Homes (1 mark). Marketing economies are when larger firms can advertise using national media and therefore spread the fixed costs across more units so reducing average cost. (1 mark). Technical economies arise when larger and more efficient capital items can be used because their high costs can be spread across a larger quantity of output (1 mark). Diseconomies of scale are increases in unit cost that occur as a business grows larger, often associated with communication issues (1 mark)

Revision Video