Economies of Scale

Lesson Objectives Understand internal and external economies of scale.

What are Economies of Scale? Economies of scale arise when the cost per unit falls as output increases. Internal Economies of Scale As a business grows in scale, its costs will fall due to internal economies of scale. An ability to produce units of output more cheaply. External Economies of Scale Are those shared by a number of businesses in the same industry in a particular area.

InternalEconomiesInternalEconomies ExternalEconomiesExternalEconomies Location Skilled Labour Transport Reputation of Area Production / Technical Purchasing / Marketing Financial Managerial Risk bearing

Internal Economies of Scale Types of economies of scaleExample Production / Technical Economies Large scale producers can employ techniques that cannot be used by a small scale producer. A large firm could use computers and technology to replace employees on a production line. Able to transport bulk materials. Mass production means that unit costs are lower. Purchasing / Marketing Economies Large businesses can employ specialist staff. Bulk buying – being able to buy goods in bulk lowers the unit price. Advertising costs can be spread. Financial Economies Easier for large firms to raise capital. Better lending terms and lower interest rates – easier to borrow money. Risk is spread over more products. Greater potential finance from retained profits. Administration costs can be spread. Managerial Economies More specialised management can be employed, saves business money because they are more efficient. Risk-bearing Economies Large firms can afford to take risks with new products / services because other parts of the businesses are still profitable.

Activity – Explain how the Ritz Hotel may benefit from internal economies of scale compared to Hotel 24. Hotel 24 in Wood Green, N22 24 beds Open Spring and Summer Offers entertainment from the same stand up comic every evening. Employs 1 manager 2 General workers, that cook, clean and everything else. The Ritz Hotel in Mayfair, W1 300 beds Open all year Offers a vast range of entertainment Employs 10 managers, 4 chiefs, 7 bar staff, 20 waiters, 30 room attendants, 15 general staff.

External Economies of Scale These are advantages gained for the whole industry, not just for individual businesses.

Examples of External Economies As businesses grow within an area, specialist skills begin to develop. Skilled labour in the area – local colleges may begin to run specialist courses. Being close to other similar businesses who can work together with each other. Having specialist supplies and support services nearby.

Examples of External Economies Better road and transport links develops as the area improve (e.g. London Docklands) Reputation of the area improves as it becomes known for a particular industry. Attracts other businesses. All of these combines to provide a mutual advantage to the businesses in the area.

Activity – Internal / External? Internal economies of scaleExternal economies of scale