Economies of Scale

These are the factors that cause average costs (cost per unit) to be lower in large-scale operations than in small-scale ones. In other words, as output grows, cost per unit falls. This can also be explained by increasing returns to scale. This is when output increases at a faster rate than inputs . Note that this is when a company grows by increasing its use of all factors of production.

(Internal) Economies of Scale.

These are the economies of scale that arise from the growth of the firm itself.

· financial economies – cheaper borrowing as the firm gets bigger and has more assets and collateral

· technical economies – the use of automated equipment where it is more cost-effective than labour

· managerial economies – can employ specialists, workers whose skills exactly match the job requirements

· purchasing economies – these are the benefits of bulk buying

· risk-bearing economies – the growth of the firm means less risk as it can diversify into different areas

Watch the video below: what type of economies of scale do you see?

IGCSE Economies & Diseconomies

Now please read the relevant section in the book (P125-7) and make additional notes on economies of scale

Diseconomies of Scale

These are the factors causing higher costs per unit when the scale of output is very large i.e. causes of inefficiency in large organisations.

Internal Diseconomies of Scale

These are the diseconomies of scale that arise from the growth of the firm itself.

· communication – a long chain of command might mean poor communication and little feedback

· co-ordination – large businesses means a high degree of delegation but empowering managers might mean departments pull in different directions

· controlling – this is difficult for the reasons outlined above

· motivating – individuals can get lost in the crowd

If you are struggling with this or if you missed the lesson, click on this video for a basic explanation

So the existence of diseconomies, or lack of existence of economies of scale can often explain why some firms remain small.

However other factors may explain the size of firms ( food retailing still has small retailers- how and why do these survive?).some firms are big and some small. For example food retailing and oil exploration are industries where economies of scale are potentially huge and therefore firms tend to be large in these industries. The recent merger of Youku and Tudou also suggests that bigger is better (check the link out).

External Economies of Scale.

These are the economies of scale that arise from the growth of the industry as a whole.

· availability of suitable labour – workers with suitable skills are on-hand. Local colleges might supply trained workers

· provision of services – specialist commercial and support services spring up e.g. distribution, insurance

· co-operation – firms might join forces for a R&D centre

· disintegration – this occurs when production is broken up so that more specialisation can take place e.g. the car industry in the West Midlands

External Diseconomies of Scale. ( Not specified in syllabus but still interesting)

These are the diseconomies of scale that arise from the growth of the industry as a whole (usually through overcrowding).

· costs increases – the price of land, labour, services and materials might rise as firms compete for a limited amount

· congestion – this might lead to inefficiency as travelling workers and deliveries are delayed

www.slideshare.net/peteroldfield/size-of-firms

Student Task: "Why are there small firms?" Exercise 4 P215. but first read and note P 216-217.

How firms Grow

You have already looked at the merger at Youku and Toudu as one example. Now read and note P 218-219 and attempt exercise 5 on the types of intergration

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