4.2.2 Economies and diseconomies of scale

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. Some examples of economies of scale are shown below:

· 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

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. Examples are:

· 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

Now read P97-99 and make additional notes if required. Copy the revision summary diagram on P97.