Lesson aims
- List external growth methods.
- Explain the difference between economies and diseconomies of scale.
Economies of scale refers to the case where the average unit cost of production decreases as the level of output increases, where unit cost refers to the cost of producing a single unit of output. In business, the explanation for this reduction in unit costs is usually described as resulting from purchasing, technical, marketing, managerial, and financial economies of scale.
Diseconomies of scale describes the case when the average unit cost of production actually increases as the level of output increases. This increase in average unit cost is usually explained by the difficulty of managing very large operations.
Economies of scale
Almost all organisations have the potential to realise economies of scale. Economies of scale can be attributed to several factors:
- Purchasing economies of scale
- Technical economies of scale
- Marketing economies of scale
- Managerial economies of scale
- Financial economies of scale
Internal Economies of Scale
- Technical
- Financial
- Managerial
- Specialization
- Marketing
- Purchasing
- Risk bearing
External Economies of Scale
External Economies of scale are forces within the industry or economy but outside of the business that lower the costs of production. These might include:
- Technological progress
- Improved transportation networks
- Abundance of skilled labour
Diseconomies of scale
It is sometimes the case that companies, or some of their operations, get so big that they become less efficient, leading to an increase in unit costs as output increases. This is called diseconomies of scale. Diseconomies of scale can be caused by several factors.
- Managerial issues
- Increase in size of the workforce
- Communication
Internal diseconomies of scale
As output progresses the business will begin to experience constant economies and thereafter diseconomies of scale. When output increases but the business experiences neither an increase nor a decrease in its Costs, the firm is experiencing Constant Economies of Scale. However as costs begin to rise with each unit of increased output, the business is now experiencing diseconomies of scale as illustrated by the rising Long Run Average Cost curve (LRAC).
Diseconomies of scale generally occur when a business is so large that it is no longer effectively able to control is costs relative to its output. Bureaucracy or red-tape or managerial diseconomies of scale are a predominant feature of companies that are experiencing diseconomies of scale.
Inefficiency also would result from workers being de-motivated in large organizations where they feel that they are insignificant. In this situation, the firms must decentralize, demerge or create subdivisions in order to decrease the inefficiency. The text outlines the following internal diseconomies:
- Lack control and coordination as the organization grows
- Communication problems
- Poorer working conditions
- Bureaucracy
- Complacency
External diseconomies of scale
External diseconomies of scale are forces within the industry or economy but outside of the business that increase the costs of production. These could be in the form of increased wage rates or material costs.
- Too many businesses in an area = high rent
- Many competitors vying for the same labour pool means you have to pay high wages
- Traffic congestion