Economies & Diseconomies of Scale

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Internal and External Economies of Scale

Economies of scale refers to the situation where, as the quantity of output goes up, the cost per unit goes down.

Internal economies of scale (EoS)

Internal economies of scale is the long run process that sees firms learn and adapt, reducing average costs as output increases.
- E.g using a new management system that increases efficiency may bring internal economies of scale.

External economies of scale (EoS)

External EoS is when the change that brings about economies of scale happens outside of the firm.
- E.g If a new road opens and this allows Ocado to deliver products more quickly and cheaply, this is a case of external economies of scale.

Economies of scale and monopolies

If having high output reduces a firm's average costs, then they can sell their products at lower prices than competitors who have lower output.
- This can eventually lead to the firm having a monopoly over the market if it's able to force its competitors out of the market.
Producing aeroplanes is expensive and there are very high fixed (and R&D) costs. The average cost of a plane falls with a higher output. Airbus and Boeing produce most of the planes in the world.

Types of Economies of Scale

There are many types of economies of scale:

Technical economies of scale

Larger firms can afford to invest in specialist technologies (or capital) which reduce the cost of production.
They can do this by spreading the initial cost of buying this technology across the large number of goods and services they sell.
A manufacturing firm can invest in specialist machines to produce their goods more efficiently as long as they produce enough for the lower cost of production to offset the upfront cost of the machines.

Purchasing economies of scale

Larger firms have more power in a market place than small firms. As firms grow they can use this power to reduce the cost of purchasing inputs from their suppliers.
Suppliers are willing to negotiate discounts on their goods and services to increase the quantities that they sell.
As a result, larger firms can buy more at a lower price per good, reducing their costs. This is often known as bulk buying and is a form of price discrimination.
- A prominent example of this is in supermarkets who buy a lot of their goods from small suppliers and can force them to take lower and lower prices due to their relative size.

Specialisation and division of labour

As firms grow, they can designate particular tasks to individuals or groups of workers.
With these workers now only doing one or a small number of jobs it becomes cost effective to give them specific training and equipment which makes them more efficient.
Specialized workers are more productive which reduces average costs.

Managerial economies of scale

Large firms can afford to invest in management technology and employ dedicated managers.
The managers and their systems can improve the productivity of the whole production process by overseeing it effectively.
- Project management tools like JIRA and Trello can help businesses to be more efficient.

Financial economies of scale

Larger firms are viewed by financial institutions (like banks) as less risky (less likely to go bankrupt) relative to smaller firms.
Banks are therefore willing to lend money at a cheaper rate as they can be more certain that the money will be repaid.

Risk-bearing economies of scale

Large firms are considered less of a risk because they tend to be in more markets. As a result the firm overall is less exposed to changes in individual markets.
Firms can be in more markets by diversifying the range of goods and services they produce or by selling to different geographical areas.
The independent shop owner selling a small number of goods is more reliant on its market than the international conglomerate who could survive having to stop selling in a particular country or stop selling a particular good.

Marketing economies of scale

Mass market advertising on TV and sponsoring large events or places (like Arsenal FC's Emirates football stadium) has a very large cost. Large businesses can spread this cost over a lot of output, whereas the local corner shop would not even be able to access this type of marketing.

Diseconomies of Scale

Diseconomies of scales describes the situation when output rises but this causes average cost to rise too.

Internal diseconomies of scale

Internal diseconomies of scale occur when firms growth begins to cause LRAC to increase (decreasing returns to scale).
As companies grow, they develop tiers of management.
- These tiers of management can increase the social distinction between employees.
- Communication can worsen, which can reduce overall efficiency.
- Managers can find it increasingly difficult to oversee and coordinate actions.

External diseconomies of scale

External diseconomies of scale is when the change that brings this about happens outside of the firm.
Increased market performance means raw materials may go up in price.
- This will increase average cost for all firms in the industry.

Long-run average cost curve

The long-run average cost curve is U-shaped.
As the curve is decreasing, there are increasing returns to scale as there are increasing economies of scale.
When the curve is flat, there are constant returns to scale.
When the curve is increasing, there are decreasing returns to scale. The upward slope of the curve shows diseconomies of scale.

Minimum efficient scale (MES)

The MES is the lowest output at which average cost is minimised in the long run.
All possible economies of scale have been achieved.
If the fixed costs of an industry are high, the MES will be large.
- E.g Building aeroplanes or the National Grid.

1Introduction to Markets

2Market Failure

2.1Market Failure

2.1.1Types of Market Failure

2.1.2Externalities

2.1.3The Deadweight Welfare Loss of Externalities

2.1.4A-A* (AO3/4) - The Externalities of Education

2.1.5Public Goods

2.1.6Information Gaps

2.1.7End of Topic Test - Market Failure

2.1.8Application Questions - Market Failure

2.2Government Intervention

2.2.1Government Intervention in Markets

2.2.2Subsidies & Price Controls

2.2.3Pollution Permits & Regulation

2.2.4A-A* (AO3/4) - European Emissions Trading

2.2.5State Provision & Information Provision

2.2.6Government Failure

2.2.7End of Topic Test - Government Intervention

2.2.8A-A* (AO3/4) - Government Intervention

3The UK Macroeconomy

3.1Measures of Economic Performance

3.1.1Measuring Economic Growth

3.1.2National Income Data

3.1.3Inflation

3.1.4Causes of Inflation

3.1.5Consequences of Inflation

3.1.6Employment & Unemployment

3.1.7Causes & Impact of Unemployment

3.1.8A-A* (AO3/4) - Hysteresis

3.1.9Balance of Payments

3.1.10Current Account Deficit & Imbalances

3.1.11End of Topic Test - Economic Performance

3.1.12Application Questions Macroeconomy

3.2Aggregate Demand

3.2.1Aggregate Demand

3.2.2Consumption

3.2.3Investment

3.2.4Government Expenditure

3.2.5Net Trade

3.2.6End of Topic Test - Aggregated Demand

3.2.7Application Questions - AD

3.3Aggregate Supply

3.3.1Aggregate Supply

3.3.2End of Topic Test - Aggregated Supply

3.3.3A-A* (AO3/4) -Aggregate Supply

3.4National Income

3.4.1National Income

3.4.2Injections & Withdrawals

3.4.3Equilibrium Level of Real National Output

3.4.4Multiplier Effect

3.4.5End of Topic Test - National Income

3.4.6Application Questions - National Income

3.5Economic Growth

3.5.1Causes of Economic Growth

3.5.2Output Gaps

3.5.3Business Cycle

3.5.4Impact of Economic Growth

3.5.5End of Topic Test - Economic Growth

3.5.6A-A* (AO3/4) - Growth

4The UK Economy - Policies

4.1Macroeconomic Objectives & Policies

4.1.1Possible Objectives

4.1.2Demand-Side Policies - Monetary

4.1.3Demand-Side Policies - Monetary 2

4.1.4A-A* (AO3/4) - The Future of Interest Rates

4.1.5Demand-Side Policies - Fiscal

4.1.6Demand-Side Policies in 2007-08

4.1.7Strengths & Weaknesses of Demand Side

4.1.8Supply-Side Policies

4.1.9Supply-Side Policies 2

4.1.10Conflicts Between Objectives

4.1.11A-A* (AO3/4) - Conflicting Incentives

4.1.12Phillips Curve

4.1.13End of Topic Topic - Policies & Objectives

4.1.14Application Questions - UK Policies

5Business Behaviour

5.1Business Growth

5.1.1Size & Types of Firms

5.1.2Business Growth

5.1.3Pros & Cons of External Expansion

5.1.4Demergers

5.1.5End of Topic Test - Business Growth

5.1.6A-A* (AO3/4) - Business Growth

5.2Business Objectives

5.2.1Business Objectives

5.2.2End of Topic Test - Business Objectives

5.2.3Application Questions - Business Objectives

5.3Revenues, Costs & Profits

5.3.1Revenue

5.3.2Costs

5.3.3Economies & Diseconomies of Scale

5.3.4Profits

5.3.5Profits 2

5.3.6End of Topic Test - Revenue, Costs & Profits

5.3.7A-A* (AO3/4) - Revenue, Costs & Profit

6Market Structures

6.1Market Structures

6.1.1Efficiency

6.1.2Perfect Competition

6.1.3Perfect Competition 2

6.1.4Monopolistic Competition

6.1.5Oligopolies

6.1.6The Prisoner's Dilemma

6.1.7Collusion in Oligopolistic Markets

6.1.8A-A* (AO3/4) - Which Factors Affect Collusion?

6.1.9Monopolies

6.1.10Price Discrimination

6.1.11Monopsony

6.1.12A-A* (AO3/4) - Models in Economics

6.1.13Contestability

6.1.14Benefits of Contestability

6.1.15End of Topic Test - Market Structures

6.1.16Application Questions - Market Structures

6.1.17A-A* (AO3/4) - Cereal Collusion

6.2Labour Market

6.2.1Demand for Labour

6.2.2Supply of Labour

6.2.3Labour Market Imperfections

6.2.4A-A* (AO3/4) - Labour Productivity & Unemployment

6.2.5A-A* (AO3/4) - What Level of Unionisation is Good?

6.2.6Wage Determination

6.2.7Elasticity of Labour Supply & Demand

6.2.8Intervention in Setting Wages

6.2.9End of Topic Test - Labour Market

6.2.10A-A* (AO3/4) - Labour Markets

6.3Government Intervention

6.3.1Reasons for Government Intervention

6.3.2Government Promotion of Competition

6.3.3Usefulness of Competition Policy & Examples

6.3.4A-A* (AO3/4) - Modern Competition Policy

6.3.5Privatisation

6.3.6Government Regulation

6.3.7A-A* (AO3/4) - Nationalisation vs Privatisation

6.3.8Government Protection of Suppliers and Employees

6.3.9Impact of Government Intervention

6.3.10End of Topic Test - Government Intervention

6.3.11Application Questions - Government Intervention

7A Global Perspective

8Finance & Inequality

8.1Poverty & Inequality

8.1.1Absolute & Relative Poverty

8.1.2Inequality

8.1.3Inequality 2

8.1.4Lorenz Curve

8.1.5Government Policy on Poverty

8.1.6End of Topic Test - Poverty & Inequality

8.1.7A-A* (AO3/4) - Inequality & Poverty

8.2Emerging & Developing Economies

8.2.1Measures of Development

8.2.2Factors Influencing Growth & Development

8.2.3Barriers to Development

8.2.4Barriers to Development 2

8.2.5A-A* (AO3/4) - The Bottom Billion

8.2.6Development Strategies

8.2.7Interventionist Strategies

8.2.8Aid

8.2.9International Institutions

8.2.10International Institutions 2

8.2.11End of Topic Test - Emerging & Developing

8.2.12Application Questions - Developing Countries

8.3The Financial Sector

8.3.1Role of Financial Markets

8.3.2Market Failure in the Financial Sector

8.3.3Role of Central Banks

8.3.4End of Topic Test - The Financial Sector

8.3.5A-A* (AO3/4) - Financial Sector

8.4Role of the State in the Macroeconomy

8.4.1Public Expenditure

8.4.2Taxation

8.4.3Public Sector Finances

8.4.4End of Topic Test - Role of the State

8.4.5Application Questions - Role of the State

9Examples of Global Policy

9.1International Policies

9.1.1Global Debt & Deficit Policies

9.1.2Poverty & Inequality Policies

9.1.3Changes in Interest Rates

9.1.4Competitiveness Policies

9.1.5End of Topic Test - International Policies

9.1.6A-A* (AO3/4) - International Policies

9.2Policy Responses to Shocks

9.2.1International Tax Policies

9.2.2Problems for Policymakers

9.2.3End of Topic Test - Policy Responses

9.2.4Application Questions - Policy Responses

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