Y2 6) Economies and Diseconomies of Scale

Summary

This video explores the concepts of economies and diseconomies of scale in business. It explains how firms can lower average costs through increasing output by utilizing internal economies of scale like managerial, technical, and purchasing efficiencies, as well as external factors such as improved infrastructure. The video also discusses diseconomies of scale, where businesses face higher average costs due to inefficiencies like poor communication, lack of coordination, and decreased employee motivation as they grow too large. The key takeaway is that while growth can bring benefits, excessive expansion can lead to diminishing returns.

Takeaways

• 😀 Economies of scale refer to a reduction in long-run average costs as output increases.
• 😀 Internal economies of scale occur within a business and are within the company's control.
• 😀 External economies of scale happen outside the firm, but still within the industry, benefiting all firms in that industry.
• 😀 The mnemonic 'really fun mums try making pies' helps remember the types of internal economies of scale: Financial, Managerial, Technical, Purchasing, Marketing, and Risk-bearing.
• 😀 Financial economies of scale occur when larger firms can negotiate lower interest rates on loans due to their stability and success.
• 😀 Managerial economies arise when large firms can employ specialist managers to improve workforce productivity.
• 😀 Technical economies happen when a firm uses specialized machinery or more specialized labor to increase productivity, despite rising costs.
• 😀 Purchasing economies occur when firms buy raw materials in bulk, obtaining discounts and lowering per-unit costs.
• 😀 Marketing economies arise when larger firms can bulk-buy advertising space, reducing the unit cost of marketing.
• 😀 Risk-bearing economies happen when large firms can spread their risks over a wider range of outputs, lowering their overall average costs.
• 😀 Diseconomies of scale occur when a firm's average costs rise as output increases, usually due to inefficiencies in management, communication, and coordination.
• 😀 Four key issues of diseconomies of scale: Control, Communication, Coordination, and Motivation, all impact productivity and raise average costs as the firm grows.

Q & A

What is the relationship between the long-run average cost curve and economies of scale?

As a firm increases its output, the long-run average cost curve typically falls, indicating economies of scale. This is because a firm can lower its average cost by producing more efficiently, benefiting from internal or external economies of scale.

What are economies of scale?

Economies of scale refer to the reduction in long-run average costs as a firm increases its output. This can occur due to more efficient production processes, better use of resources, or reductions in per-unit costs.

What is the difference between internal and external economies of scale?

Internal economies of scale occur within a business, where the firm gains efficiencies as it grows, such as through better management or purchasing power. External economies of scale, on the other hand, occur outside the firm but within the industry, benefiting all firms within that industry, such as improved infrastructure or research collaboration.

How do managerial economies of scale work?

Managerial economies of scale occur when a firm employs specialist managers as it grows. These managers improve productivity by overseeing workers more effectively and utilizing their specialized skills, leading to increased output and lower average costs.

What are purchasing economies of scale?

Purchasing economies of scale happen when a firm buys raw materials in bulk as it grows. This allows the firm to negotiate discounts, reducing the per-unit cost of materials and lowering average costs as production increases.

How do technical economies of scale reduce costs?

Technical economies of scale involve using specialized machinery or increasing labor specialization, which boosts productivity. While costs may rise due to new equipment or more workers, productivity increases faster, resulting in lower average costs.

What are the potential financial benefits of economies of scale?

As a firm grows, it can negotiate lower interest rates for loans due to its increased size and stability. This reduces financial costs, and the cost of financing can be spread over a larger output, reducing average costs.

What are external economies of scale, and how do they benefit firms?

External economies of scale occur outside a single business but within an industry. For example, improved transport infrastructure, proximity to component suppliers, or shared research and development can lower costs for all firms in the industry, benefiting their growth and reducing average costs.

What are diseconomies of scale?

Diseconomies of scale occur when a firm becomes too large, and its average costs increase as output rises. This can happen due to inefficiencies such as poor management, communication problems, or a decline in worker motivation.

What are the key problems that lead to diseconomies of scale?

The four main problems leading to diseconomies of scale are control issues, communication barriers, coordination difficulties, and decreased motivation among workers. These factors can reduce productivity and increase average costs as the firm grows.