Economies of Scale
Business: Edexcel IGCSE, topic 5.1.1
Economies of Scale
Economies of scale describes companies benefiting from a reduction (fall) in the average unit cost of their product or service because of increasing production (the number of units produced). A lower average cost per unit can let a business make higher profits or charge a lower price. Economies of scale can come from:
Purchasing economies of scale
- This is when larger companies get discounts from their suppliers because they are buying lots of units in bulk.
- In the same way, the average price of a can of Coca-Cola is lower if you buy a 6-pack instead of a single can.
- Businesses usually get a lower (cheaper) average cost if they are buying more products and buying things like raw materials in bulk.
Technical economies of scale
- This happens because larger companies are able to invest in expensive, specialist machinery and equipment.
- For example, Tesco can afford to invest in expensive technology that maximises the efficiency of their stock (in warehouses etc).
- But a local corner shop may not be able to afford the technology or system. For the corner shop, the costs outweigh the benefits of the technology.
Diseconomies of Scale
Diseconomies of scale happen when a business grows so large that the business’ products average unit cost (cost per unit) increases. Diseconomies of scale can happen for a number of reasons:
Coordination issues
- As a firm grows, the way the firm functions or operates becomes more complex.
- There may be new departments and different teams located in different places (nationally or internationally).
- This can make it harder and more expensive to manage effectively. This can lead to diseconomies of scale.
Communication issues
- In a larger business, communication becomes more difficult because of the size of the workforce and the number of different divisions in the business.
Lower employee motivation
- Workers can become demotivated if they feel like a cog in a wheel and can’t see the impact of their work on the business’ overall performance.
- This can lead to a drop in productivity and an increase in average unit cost.
Test yourself on Economies of Scale
What are the 2 main types of economies of scale?
"This is when larger companies get discounts from their suppliers because they are buying lots of units in bulk." Which type of economies of scale is this?
Which cause of diseconomies of scale does this show?