1. IB Business and Management
1.6 – Economies and Diseconomies of Scale

2. Learning Outcomes
Apply the concepts of Economies and Diseconomies of Scale to business decisions
Evaluate the relative merits of small versus large organisations

3. What are Economies of Scale?
Economies of scale occur when the average unit cost to produce each unit falls as the firm gets larger
Tip: It is ‘unit costs’ that will decrease NOT total costs
In what ways is this a huge benefit to large businesses?

4. Types of Economy
Internal Economies – those economies that come from within the firm
External Economies – those economies that occur within a whole industry

5. Types of Internal Economies
There are 7 types of economies of scale:
Purchasing
Marketing
Managerial
Financial
Technical
Specialisation
Monopsony
What can you tell me about any of these different types of economy?

6. Purchasing Economies Larger firms buy materials in larger amounts
They will get discounts from suppliers for large orders
This is called bulk-buying
The cost per unit will be lower

7. Marketing Economies
Advertising and marketing can be a huge expense for a business
The more items a company sells the more units this cost can be spread over
Eg. A company places an advert which costs £1, units are sold this is £2 per item. If 2000 are sold this is 50p per item
Businesses also benefit from being able to sell in bulk. Admin costs and distribution costs will be cheaper per unit

8. Managerial Economies
In small businesses one manager will often have to fulfill many functions
In larger firms, managers can specialise which means that they can be expert in their area of work and therefore more efficient

9. Financial Economies
Large companies are seen to be less of a credit risk than small companies
Banks will tend to lend to bigger companies at lower rates of interest
Also cheaper sources of finance such as trade credit are more widely available

10. Technical Economies
Large businesses are more likely to be able to afford more sophisticated machinery
They will also use any machinery more effectively
In small businesses machinery may lay unused for most of the day whereas in a larger firm it may be used nearer to full capacity

11. Specialisation Economies
Similar to managerial economies
Other workers can also specialise.
This is called ‘division of labour’
Workers develop expertise in their particular area of the business, resulting in greater productivity

12. Monopsony Economies Similar to purchasing economies
Specifically refers to large firms being in a strong buying position.
They can negotiate with suppliers for even larger discounts and suppliers want their custom badly

13. What type of economy?

14. Question 1
The business hires a full time accountant to deal with the business finances

15. Question 2
Conveyor belts & specialised machinery are purchased for producing in huge numbers

16. Question 3
Large businesses have more power to negotiate prices down with suppliers as their custom is important

17. One advert can sell 100,000 items or 100 items – the cost is the same
Question 4
One advert can sell 100,000 items or 100 items – the cost is the same

18. Using CAD speeds up the design process
Question 5
Using CAD speeds up the design process

19. Question 6
HSBC offer a lower rate of interest to bigger businesses who they consider to be less of a risk

20. Question 7
Printing leaflets to advertise the business costs $100 for 1000 leaflets but only $200 for 10,000

21. Question 8
HSBC offer a lower rate of interest to bigger businesses who they consider to be less of a risk

22. When buying large quantities of goods, the price per unit is cheaper
Question 9
When buying large quantities of goods, the price per unit is cheaper

23. Question 10
Workers and managers can specialise in one area which means they will be more productive

24. Fixed delivery costs are spread over a larger number of items
Question 11
Fixed delivery costs are spread over a larger number of items

25. Question 12
Trade Credit and other cheap forms of finance might be available to larger firms

26. Machines can do work more quickly and with less mistakes and wastage
Question 13
Machines can do work more quickly and with less mistakes and wastage

27. External Economies of scale….
Where falling average costs occur due to the whole industry growing (particularly in a certain area)

28. External Economies Skilled Labour Suppliers and Ancillary Services
Cooperation
How could each of these lead to decreased unit costs?

29. Sometimes larger businesses may suffer from diseconomies of scale ……..
BUT…….
Sometimes larger businesses may suffer from diseconomies of scale ……..

30. Outweighing economies
Unit Costs- Graph
Economies of scale
Reducing unit costs
Cost Per Unit
Diseconomies of scale
Outweighing economies
Lowest Unit Costs
Output

31. Question
Why might ‘unit costs’ start to increase again?

32. Diseconomies of Scale
Where average unit costs rise as the business grows larger
Diseconomies of scale tend to occur because it is more difficult to manage a large business than a small one

33. Examples of Internal Diseconomies of Scale
Bureaucracy
Poorer Labour relations
‘Small fish in a big pond’
Communication difficulties
Lack of Control and Coordination
Too much specialisation demotivates workers
Complacency
How could these factors lead to an increase in average unit costs?

34. External Diseconomies
Land scarcity leading to increased rents
Traffic congestion
Pressure to increase wages to attract new workers

35. Is Growth always desirable?

36. Questions….. Do all firms want to grow?
Why do we still have small firms?
What disadvantages might there be of being a big firm?

37. Why do we still have small firms?
No motivation
to grow
Less
Paperwork
New
Companies
Why do we still have small firms?
Personal
Service
Greater
Flexibility
Lower Costs
Cost
Niche
Markets

38. Potential problems with growth
Increased costs
Liquidity problems (if growth is too fast)
Difficulties in communication/coordination
Diseconomies of Scale