Everything you need to know about Diseconomies of scale and economies of scale.

Economies of scale

- Economies of scale are essentially the cost reductions to large firms for buying a large quantity of a product/ buying in bulk.  Creating Economies of Scale;  - Some firms actually try to increase economies of scale in their industry. Why do Unilever and Proctor & Gamble spend so much on advertising soap powders? The reason is that it makes it more difficult to enter the industry. A new firm would have to spend a large amount on advertising (fixed cost) to enter the industry. Therefore, we get marketing economies of scale. There is no point in spending £10 million a year on advertising unless we can get a pretty good return on sales. The marketing economies of scale makes it difficult for new firms (the advertising is also a sunk cost). Examples: if a large firm decides to buy spoons, buying 100 spoons will be more cost effective than buying only one spoon. due to economies of scale. a price of 1 unit of the 100 spoons will be cheaper. Often, the cost of buying 100 spoons is not much more expensive than the price of buying 1 spoon. 1 spoon = 50p 100 spoons = 99p. It would make sound economical sense to buy in bulk.     

Economies Of Scale Growth In Firm (image/png)

The diagram shows that a small firm has higher average costs so this increases the price.  As output increases, it leads to lower average costs to firms. we see this with the price level falling  from P1 to P2, this effect leads to lower average costs to firms.  Increasing output from Q1 to Q2, we see a decrease in long-run average costs from P1 to P2. Economies of scale are important because they mean that as firms increase in size, they can become more efficient. For certain industries, with significant economies of scale, e.g aeroplane manufacture, it is important to be a large firm; otherwise they will be inefficient.

Economies of scale

Diseconomies of scale

Diseconomies of scale start to occur when the LRAC curve starts to rise with increasing  output.   Reasons for dis-economies of scale Poor communication in a large firm. It can be hard to communicate ideas and new working practices. Alienation: Working in a highly specialized assembly line can be very boring if workers become de-motivated. In a large firm, there is an increased gap between top and bottom e.g. call centers Lack of control: when there is a large number of workers it is easier to escape with not working very hard because it is more difficult for managers to notice shirking. Relationship with economies of scale If a firm faces constant input costs, then decreasing returns to scale imply rising long run average costs and diseconomies of scale. However, it is possible that if the firm gains purchasing economies then increasing the factor inputs by 50% may not actually increase costs by 50%. Therefore, it is possible to have decreasing returns to scale, but not necessarily diseconomies of scale. But, if we assume a constant input price, decreasing returns will cause diseconomies of scale.  

Diseconomies of scale

Economies Of Scale 2 (image/jpeg)

The diagram shows that the LRAC curve starts to increase. This is noticably after output Q2. We can only produce so much/ buy so much util prices inflate.  Overcoming Diseconomies of scale Firms may attempt to overcome diseconomies of scale by splitting up the firm into more manageable sections/ departments. For example, a large multinational may be split up into local geographical areas, with local managers facing incentives to maximise efficiency.