Economies of Scale Explained | Think Econ
Summary
TLDRThe video script delves into the concept of economies of scale, explaining how businesses gain cost advantages as production becomes more efficient. It distinguishes between internal and external economies, illustrating how larger companies often have a competitive edge due to cost savings spread over a larger number of goods. The script uses the smartphone industry as a vivid example and touches upon the limitations of economies of scale, such as in restaurant kitchens. It concludes by emphasizing the importance of economies of scale for businesses seeking a competitive advantage and the benefits for the overall economy.
Takeaways
- 📈 Economies of scale are cost advantages that companies gain when production becomes more efficient through increased output.
- 🏭 Larger companies generally experience greater cost savings due to economies of scale, as they can spread fixed costs over a larger number of products.
- 🔍 Economies of scale can be internal, stemming from management decisions, or external, influenced by factors like labor and material costs.
- 🤖 Specialization of labor and the use of integrated technology can lead to increased output volumes and contribute to economies of scale.
- 💼 Bulk purchasing and lower borrowing costs from banks or other lenders can reduce per-unit costs, enhancing economies of scale.
- 📊 Spreading the cost of internal functions across more units produced and sold helps to lower the overall cost per unit.
- 🚀 Companies can create diseconomies of scale if they grow too large and become less efficient, as illustrated by the 'too many cooks' example in restaurant kitchens.
- 📱 The smartphone industry is highlighted as an example where large companies like Apple and Samsung benefit significantly from economies of scale.
- 🛒 Businesses can achieve economies of scale by buying in bulk, which often leads to discounted per-unit prices.
- 🛠️ Companies can realize internal economies of scale by reorganizing resources for greater efficiency, leading to larger profit margins.
- 🌐 External economies of scale can be realized by growing in size relative to competitors and using that size to negotiate better deals and practices.
Q & A
What is the definition of economies of scale?
-Economies of scale refer to the cost advantages that companies attain when their production becomes more efficient, typically achieved by increasing production and lowering costs as the costs are spread over a larger number of goods.
How do companies benefit from economies of scale?
-Companies benefit from economies of scale by achieving cost savings as they produce more, which allows them to spread the fixed costs over a larger number of units, thereby reducing the cost per unit.
What are the differences between internal and external economies of scale?
-Internal economies of scale are based on management decisions such as accounting, information technology, and marketing, which improve efficiency within the company. External economies of scale are related to outside factors like the cost of acquiring labor or intermediate goods for production.
Why do larger companies often have a competitive advantage over smaller ones?
-Larger companies often have a competitive advantage because they can produce more and spread the cost of production over a larger amount of goods, which generally results in lower per-unit costs and the ability to price products more competitively.
What are the three main reasons economies of scale lead to lower per-unit costs?
-The three main reasons are: specialization of labor and integrated technology which boosts output volumes, lower per-unit costs from bulk orders and borrowing capital at lower rates, and spreading internal function costs across more units produced and sold.
Can you give an example of economies of scale in the smartphone industry?
-An example is the cost difference between an individual trying to build a single smartphone versus companies like Apple or Samsung producing millions. The individual lacks the parts, manufacturing capabilities, and expertise, resulting in a much higher cost compared to the mass-produced, efficiently manufactured smartphones by these companies.
What is the concept of diseconomies of scale?
-Diseconomies of scale occur when a company becomes too large and the pursuit of further economies of scale leads to decreased efficiency and increased costs, often due to management challenges or operational bottlenecks.
How can the phrase 'Too many cooks spoil the broth' relate to diseconomies of scale?
-The phrase illustrates the idea that adding more resources (like cooks) beyond a certain point can lead to inefficiency and reduced output, which is similar to diseconomies of scale where increased size starts to negatively impact productivity.
How can a company realize internal economies of scale?
-A company can realize internal economies of scale by reorganizing the distribution of its resources, such as equipment and personnel, to make operations more efficient, which in turn can lead to larger profit margins.
How can a company realize external economies of scale?
-A company can realize external economies of scale by growing in size relative to its competitors and using that size to engage in competitive practices, such as negotiating discounts for bulk purchases.
Why are economies of scale important for businesses and investors?
-Economies of scale are important because they provide businesses with a competitive advantage in their industry. Investors look for companies that can achieve economies of scale as it signals potential for growth and profitability.
Outlines
📈 Economies of Scale: The Competitive Advantage of Large Companies
This paragraph introduces the concept of economies of scale, explaining how companies achieve cost advantages as production becomes more efficient. It highlights that larger companies often have a competitive edge due to their ability to spread costs over a greater number of goods, leading to cost savings. The paragraph also differentiates between internal economies of scale, which are influenced by management decisions, and external economies, which are affected by factors outside the company. The importance of economies of scale in all industries is emphasized, as is the reason why smaller businesses might charge more for similar products. The paragraph concludes with three main reasons for lower per unit costs due to economies of scale: specialization of labor, bulk orders, and spreading internal function costs.
Mindmap
Keywords
💡Economies of scale
💡Cost advantages
💡Internal economies of scale
💡External economies of scale
💡Specialization of labor
💡Bulk purchasing
💡Diseconomies of scale
💡Competitive advantage
💡Production efficiency
💡Cost per unit
Highlights
Economies of scale are cost advantages attained by companies when their production becomes more efficient.
Companies achieve economies of scale by increasing production and lowering costs, spreading costs over a larger number of goods.
The size of the business often matters, with larger companies experiencing more cost savings.
Economies of scale can be both internal, based on management decisions, and external, influenced by outside factors.
Internal economies of scale include accounting, information technology, and marketing decisions.
External economies of scale relate to the cost of acquiring labor or intermediate goods for production.
Economies of scale explain why large companies often have a competitive advantage over smaller ones.
Cost per unit depends on production volume and cost of production, allowing larger companies to charge less.
An industry's ability to dictate product costs is influenced by the production of similar goods by multiple companies.
Three main reasons for lower per unit costs due to economies of scale: specialization of labor, bulk orders, and spreading internal function costs.
Specialization of labor and integrated technology boost output volumes.
Bulk orders from suppliers and lower borrowing costs contribute to lower per unit costs.
Spreading internal function costs across more units helps reduce overall costs.
Diseconomies of scale occur when a company becomes too large and the pursuit of economies of scale backfires.
A smartphone example illustrates the cost difference between individual and mass production.
Restaurant kitchens demonstrate the limitations of economies of scale with too many cooks in a small space.
Economies of scale can be achieved through internal reorganization and external competitive practices.
Investors look for economies of scale when selecting investments, as they provide a competitive advantage.
The pursuit of economies of scale leads to increased efficiency, benefiting the economy and markets.
Transcripts
Hey everyone and welcome back to the channel. Today we're going to be talking about a key
microeconomic concept known as economies of scale. With that said let's get right into it.
Alright so let's start off answering perhaps the most important question you're wondering:
What are economies of scale? Well, put in simple terms, economies of scale are cost advantages
attained by companies when their production becomes more efficient. Companies can achieve
economies of scale by increasing production and lowering costs; and this is possible since the
costs are spread over a larger number of goods. Does that sound confusing? Allow me to explain.
The size of the business often matters when it comes to economies of scale. The larger the
company, the more the cost savings. Economies of scale can be both internal and external. Internal
economies of scale are based on management decisions including things like accounting,
information technology, and marketing, while external has to do with the outside factors
like the cost of acquiring labor or intermediate goods to be used in production. Economies of scale
are an important concept for all businesses in all industries. It explains why large companies
oftentimes have a competitive advantage over smaller companies. Have you ever wondered why
a smaller business charges more for a similar or even identical product sold by a larger company?
That's because the cost per unit depends on how much the company produces as well as how much
it costs them to produce. Larger companies can produce more by spreading the cost of production
over a larger amount of goods. An industry may also be able to dictate the cost of a product if
several different companies are producing similar goods within the industry. Now there are three
main reasons why economies of scale have led to lower per unit costs. First, specialization of
labor and more integrated technology boosts output volumes. Second, lower per unit costs can come
from bulk orders from suppliers as well as lower costs of borrowing capital from banks or other
loan providers. Third, spreading internal function costs across more units produced and sold helps to
reduce costs. A company can create a diseconomy of scale when it becomes too large and chases an
economy of scale, but we'll give an example of that in just a second. As a dramatic example of
economies of scale think of a smartphone. How much money do you think it would cost for you, yes you,
the person watching this video right now, to build a single smartphone all by yourself? Well after
considering the cost of hardware, materials, and the knowledge you'll need to achieve such a feat,
I'm willing to bet the cost is somewhere in the ballpark of quite a lot of money. Definitely more
than the five to six hundred dollar range that it costs Apple or Samsung. But why does it cost
you so much more to make? Well in this example it's quite obvious. You don't have the parts,
the manufacturing capabilities, and likely the expertise to make smartphones as efficiently
as these companies do. So while they're pumping out hundreds of millions of smartphones each year
and raking in a hefty profit per individual phone you're probably in debt just from creating one all
by yourself. What about dis economies of scale? Restaurant kitchens are often used to illustrate
how economies of scale are limited. More cooks in a small space get in each other's way and become
less efficient. This is the case even though intuitively more cooks should equal more output.
Have you ever heard of the phrase "Too many cooks spoils the broth"? Well this is more or less what
that saying is getting at. Economies of scale are advantages that sometimes occur as a result of
increasing the size of a business. For example, a business might enjoy an economy of scale
concerning its bulk purchasing. By buying a larger number of products at once it could negotiate
a lower per unit price than its competitors as buying in bulk often results in a discounted price
per unit. Put simply, economies of scale can be achieved in two ways: first, a company can realize
internal economies of scale by reorganizing the way their resources such as equipment and
personnel are distributed within the company. That is, making the company more internally efficient
results in larger profit margins. Second, a company can realize external economies of scale
by growing in size relative to their competitors and then using that increased size to engage
in competitive practices such as negotiating discounts for bulk purchases. Economies of scale
are important because they help provide businesses with a competitive advantage in their industry.
Companies will therefore try to realize economies of scale whenever possible just as investors will
try to identify economies of scale when selecting investments. This will lead to companies striving
to become more and more efficient which is generally good for the economy and the markets
as a whole. We hope that this video helped you to understand the concept of economies of scale.
If you enjoyed the video be sure to let us know by liking the video, subscribing to the channel,
and commenting what sort of economic topics or homework questions you'd like to see us
cover in the future. Thanks for watching this video and we'll catch you in the next.
Ver Más Videos Relacionados
6 Advantages of Cloud Computing
Cost leadership: When a company sells cheap and makes money
Economies of Scale in One Minute: Definition/Theory, Explanation and Examples
Economies of Scale and Long-Run Costs- Micro Topic 3.3
Explained Supply Chain Management in 10 Minutes
Just in Time Production Explained | Toyota, Dell and Walmart Examples
5.0 / 5 (0 votes)