Economies of Scale (Edexcel IGCSE Business)

• As a business grows, it is able to increases its scale of output
• This generates efficiencies that lower its average costs (AC) of production
  • These efficiencies are called economies of scale
  • Economies of scale help large firms lower their costs of production beyond what small firms are able to achieve
    
    
• Economies of scale can result in lower average (or unit) costs, not lower total costs
  • The total costs will increase, but at a decreasing rate per unit

Diagram: Economies of Scale & Average Costs

 Economies of scale lower average costs as the scale of output increases

Diagram analysis

• With relatively low levels of output, the firms average costs are high
• As the firm increases its output, it begins to benefit from economies of scale which lower the average cost per unit
• The business will reach a level of output at which costs are minimised
• Beyond this point, diseconomies of scale will occur and the average cost will start to rise again
   

Internal economies of scale

• Internal economies of scale reduce average costs for a business when it grows
• Economies of scale are generated by several internal factors, some of which the business has control over
• Two key internal economies of scale relate to purchasing and the ability of larger businesses to employ specialist managers

Explanation of Purchasing & Managerial Economies of Scale

Type of Economy of Scale	Explanation
Purchasing Economy	Occurs when large firms buy raw materials or components in greater volumes and receive a bulk purchase discount, which lowers the average cost This provides a cost advantage over smaller businesses
Managerial Economy	Occurs when large firms can employ specialist managers who are skilled and efficient at certain tasks, and this efficiency lowers the average cost They may attract the best talent from other businesses increasing competitive advantage

External Economies of Scale

• External economies of scale lower average costs for individual businesses when the market as a whole grows
  
  
• Examples of external benefits include
  • Better-skilled workforce
    • A large and growing industry leads to an increased concentration of workers with industry-specific skills
    • These workers require less training and tend to be productive quickly following recruitment
    • Local educational institutions are likely to provide skills-based qualifications that are relevant to the growing industry
      
      
  • Improved infrastructure
    • A growing industry that employs many people is in a good position to persuade local authorities to improve transport and communications structure to meet its needs
    • This can make distribution more efficient and improves the effectiveness of business operations