Economies and diseconomies of scale

1
Economies and diseconomies of scale

• Lesson objectives Students to learn how to
• Apply the concepts of economies and diseconomies
  of scale.

2
Economies of scale

• Economies of scale lead to reductions in unit
  costs as the scale of operation increase.

Average costs
Scale of operation
3
What is meant by an increase scale of operation

• This refers to any increase in the capacity of a
  business. It could be achieved by
• Buying new machinery
• Building a bigger factory / shop / plane / ship
• Merger

4
How do unit or average costs fall as the scale of
production increases? 1

• Technical economies using large scale
  productive equipment. Whilst this equipment is
  expensive the large output leads to reduced unit
  costs. To acquire such equipment requires that
  the business has the finance and the demand.
• Marketing economies selling in bulk reduces
  admin / transport costs. Also large scale selling
  can be supported with a marketing budget that
  does not need to increase with the sales revenue
  generated. Eg a television advert costing 1m can
  support 4m sales a day or 8m sales a day.
• Financial economies larger businesses are
  simply less likely to go bankrupt and they have
  sizable assets they can use as collateral. They
  can negotiate the interest they pay on loans and
  even issue their own debt (commercial bonds).

5
How do unit or average costs fall as the scale of
production increases? 2

• Managerial economies as businesses expand they
  employ specialist managers. The boss with a eye
  on each business function becomes departments
  staffed by specialists.
• Whilst this increases the managerial salary bill
  these managers are experts.
• Human resource managers now recruit better
  suited candidates who fit with the organisations
  needs and culture. Employees stay longer, are
  more motivated and more productive.
• Production managers can re-arrange production so
  that it is more efficient and they have better
  knowledge regarding what equipment to purchase.
• Purchasing economies bulk buying discounts

6
External economies

• These occur when an industry develops in a
  certain area
• Pool of trained workers
• Ancillary services marketing, accountancy to
  cleaning
• Co-operation between businesses eg on research
  and development
• Development of specialist suppliers of components
  and raw materials

7
Limits?

• There are likely to be limits to economies of
  scale. How large can machinery get? How large can
  markets get? How large can a plane get!? You get
  the idea?

8
Diseconomies of scale

• Business can become too large. Unit costs can
  then tend to rise.
• Causes
• Communication hierarchical structure,
  information overload, formal methods, less face
  to face, language.
• Co-ordination different departments must work
  towards same goals.
• Motivation being a small fish in a big pond
  syndrome. Less contact with senior managers.
• Technical diseconomies if a large machine
  breaks down production costs can rise.

9
Do diseconomies exist?

• Evidence suggests that unit costs may not rise as
  the scale of production increases beyond an
  optimum scale.
• Task! Diseconomies can be addressed. Consider how
  each can be overcome within a multi-national
  business.

10
Why do businesses grow?

• Exploit economies of scale
• Increase profits
• Increase market share / sales
• Obtain monopoly power be the market leader on
  price
• Diversify thus reduce risk

Task! Question 2, page 588 and Question 3b, page
589 (3 X 5 marks)
11
Why do small firms survive?Why do they stay
small?
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Reasons

• Lack of economies of scale. (Except, perhaps,
  bulk buying discounts).
• Niche markets / size of the market (eg could be a
  local market)
• Objectives of the business
• Also.
• Niche markets may not be worth entering for
  larger businesses.

13
Large or small?

• Draw up a list of advantages and disadvantages of
  being a
• Large business
• Small business
• Which is best suited to
• Car manufacturing
• Dentistry
• Food retail
• For each of these evaluate by completing a
  sentence beginning with To some extent it
  depends on Write at least one more sentence to
  complete your evaluation.