Economies of scale are basically the increase in efficiency of production as the number of goods being produced in a firm increases. Typically, a firm that achieves economies of scale lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods. Fixed costs are those costs of production that do not change when output changes. There are two types of Economies of Scale: Internal economies External economies Internal economies of scale are those benefits the firm gains from its own growth.
Technical economies of scale Large-scale businesses can afford to invest in expensive and specialist capital machinery which increases the output level and thus costs would decrease because not many workers would be needed in such fields. Specialization of the workforce Larger businesses split complex production processes into separate tasks to boost productivity. By specializing in certain tasks or processes, the workforce is able to produce more output in the same time.
Marketing economies of scale
A large firm can spread its advertising and marketing budget over a large output and it can purchase its inputs in bulk at negotiated discounted prices. A good example would be the ability of the major food retailers who have buying power when purchasing supplies from farmers and other suppliers. Financial economies of scale Larger firms are usually rated by the financial markets to be more ‘credit worthy’ and have access to credit facilities, with favorable rates of borrowing.
Businesses quoted on the stock market can normally raise extra financial capital more cheaply through the issue of shares.
Managerial economies of scale When a firm is small, the manager is probably the owner. Not only will he direct his staff, but also he will probably run the office too and perhaps even do the accounts. As the firm gets bigger, he can begin to appoint specialist managers, an office manager, a typist and an accountant.
They are all likely to be more efficient in their chosen field, so the firm’s cost per unit of output will fall. External economies of scale are those benefits that firms gain from the growth of the industry and not just from a particular firm. Communication and Transport Due to growth of industries, more facilities are available in terms of transport and communication. E. g. the infrastructure is improved, more railway lines are built. These factors reduce distribution costs. Education
In some economies, certain skills are demanded more than others, and thus the labor force needs to be trained in order to specialize in these fields. This results into more colleges and universities being built in order to meet demand for skills. Housing Some firms are located in areas that are sparsely populated or are in a very inconvenient location. Improved housing and living facilities encourages people to move into the area and to work for the firm. Banking and Insurance Development of banking and insurance services in area attracts more people to the area.
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