Economies of scale occurs when the average costs of a firm decrease due to increased output. On the other hand, diseconomies of scale occur when the average costs of a firm increase due to increased output. This can be shown on the diagram below:
The minimum efficient scale is the point at which the curve first stops falling and levels off. This is the minimum output required by the firm to full exploit economies of scale. Both of the red lines represent all the output values in which the firm is fully exploiting economies of scale, before diseconomies of scale set in.
Internal economies of scale
This is when just the individual firm benefits of increased output. The internal economies of scale are as follow:
One of the benefits of being big is that a big firm is more likely to get approved to take out a bank loan and at a lower rate of interest than smaller firms. The main reason for this is due to the fact that larger firms are often associated as being more reputable and therefore less risky. This means that banks will be happy to lend a large firm a loan and do so at a lower interest rate, as they do not need to charge higher rates of interest to make up for the higher risk investment.
A large firm is able to afford specialist machinery that smaller firms are unable to. This specialist machinery leads to a decrease in the firm’s average costs, thus increasing their competitiveness within the market. In addition to this, larger firms can afford to split their production process into different tasks through the division of labour. This is often seen in the automotive industry and is known to increase the efficiency of production. Furthermore, larger firms are also able to benefit through the law of increased dimensions. This occurs when doubling the height and width of a lorry or warehouse etc leads to a more than proportionate increase in the cubic storage space available. The benefit of this applies mainly to large firms within transport and distribution industries.
Larger firms are able to split themselves up in to different departments where they can afford to employ specialist mangers e.g. human resources, finance etc. As each of these managers are specialized in their department, efficiency and productivity within the firm increases.
The larger the firm, the larger the output produced. As a result of this, marketing costs are spread over a larger output. Therefore the firm is able to spend more money on marketing as the marketing cost per good/service or customer is cheaper than that of a smaller firm. In addition to this, as a large firm is able to spend more money on advertisement, they are also likely to have more leverage over advertisement companies in terms of price than that of a smaller firm.
Large firms are likely to be able to purchase goods or raw materials at a lower price than smaller firms. This is due to… Read more