Economies & Diseconomies of Scale (CIE IGCSE Economics)

• As a firm grows, it is able to increases its scale of output generating efficiencies that lower its average costs (AC) of production
  • These efficiencies are called economies of scale
  • Economies of scale help large firms to lower their costs of production beyond what small firms are able to achieve
     
• As a firm continues increasing its scale of output, it will reach a point where its average costs (AC) will start to increase
  • The reasons for the increase in the average costs are called diseconomies of scale
      
• Internal economies of scale occur as a result of the growth in the scale of production within the firm

 Economies of scale occur when average costs decrease with increasing output & diseconomies of scale occur when average costs increase with increasing output

  

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
• At some level of output, a firm will not be able to reduce costs any further - this point is called productive efficiency
• Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale

Types Of Internal Economies & Diseconomies of Scale

Internal Economies of Scale	Diseconomies of Scale
Financial Economies Managerial Economies Marketing Economies Purchasing Economies Technical Economies Risk-bearing Economies	Management Diseconomies Communication Diseconomies Geographical Diseconomies Cultural Diseconomies

• External economies of scale occur when there is an increase in the size of the industry in which the firm operates
  • The firm is able to benefit from lower average costs (AC) generated by factors outside of the firm
    
    

Sources Of External Economies Of Scale

Source	Explanation
Geographic Cluster	As an industry grows, ancillary firms move closer to major manufacturers to cut costs & generate more business. This lowers the AC e.g. car manufacturers in Sunderland rely on the service of over 2,500 ancillary firms
Transport Links	Improved transport links develop around growing industries in order to help get people to work & to improve the transport logistics. This lowers the AC e.g. Bangalore is know as India's Silicon Valley & transportation projects have been successful in transforming the movement of people & goods
Skilled Labour	An increase in skilled labour can lower the cost of skilled labour, thereby lowering the AC. The larger the geographic cluster, the larger the pool of skilled labour
Favourable Legislation	This often generates significant reductions in AC as governments support certain industries in order to achieve their wider objectives