Download Economies and Diseconomies of Scale

IB Business and
Management
1.6 – Economies and Diseconomies
of Scale
Learning Outcomes
• Apply the concepts of Economies and
Diseconomies of Scale to business
decisions
• Evaluate the relative merits of small versus
large organisations
What are Economies of Scale?
• Economies of scale occur when the average
unit cost to produce each unit falls as the
firm gets larger
Tip: It is ‘unit costs’ that will decrease NOT
total costs
In what ways is this a huge benefit to large
businesses?
Types of Economy
• Internal Economies – those economies that
come from within the firm
• External Economies – those economies that
occur within a whole industry
Types of Internal Economies
There are 7 types of economies of scale:
• Purchasing
• Marketing
What can you tell me
• Managerial
about any of these
• Financial
different types of
economy?
• Technical
• Specialisation
• Monopsony
Purchasing Economies
• Larger firms buy materials in larger amounts
• They will get discounts from suppliers for
large orders
• This is called bulk-buying
• The cost per unit will be lower
Marketing Economies
• Advertising and marketing can be a huge
expense for a business
• The more items a company sells the more units
this cost can be spread over
• Eg. A company places an advert which costs
£1,000. 500 units are sold this is £2 per item. If
2000 are sold this is 50p per item
• Businesses also benefit from being able to sell
in bulk. Admin costs and distribution costs will
be cheaper per unit
Managerial Economies
• In small businesses one manager will often
have to fulfill many functions
• In larger firms, managers can specialise
which means that they can be expert in their
area of work and therefore more efficient
Financial Economies
• Large companies are seen to be less of a
credit risk than small companies
• Banks will tend to lend to bigger companies
at lower rates of interest
• Also cheaper sources of finance such as
trade credit are more widely available
Technical Economies
• Large businesses are more likely to be able to afford
more sophisticated machinery
• They will also use any machinery more effectively
• In small businesses machinery may lay unused for
most of the day whereas in a larger firm it may be
used nearer to full capacity
Specialisation Economies
•
•
•
•
Similar to managerial economies
Other workers can also specialise.
This is called ‘division of labour’
Workers develop expertise in their particular
area of the business, resulting in greater
productivity
Monopsony Economies
• Similar to purchasing economies
• Specifically refers to large firms being in a
strong buying position.
• They can negotiate with suppliers for even
larger discounts and suppliers want their
custom badly
What type of economy?
Question 1
The business hires a full time accountant to deal with
the business finances
Question 2
Conveyor belts & specialised machinery are purchased
for producing in huge numbers
Question 3
Large businesses have more power to negotiate prices
down with suppliers as their custom is important
Question 4
One advert can sell 100,000 items or 100 items – the
cost is the same
Question 5
Using CAD speeds up the design process
Question 6
HSBC offer a lower rate of interest to bigger businesses
who they consider to be less of a risk
Question 7
Printing leaflets to advertise the business costs $100 for
1000 leaflets but only $200 for 10,000
Question 8
HSBC offer a lower rate of interest to bigger businesses
who they consider to be less of a risk
Question 9
When buying large quantities of goods, the price per
unit is cheaper
Question 10
Workers and managers can specialise in one area which
means they will be more productive
Question 11
Fixed delivery costs are spread over a larger number of
items
Question 12
Trade Credit and other cheap forms of finance might be
available to larger firms
Question 13
Machines can do work more quickly and with less
mistakes and wastage
External Economies of
scale….
Where falling average costs occur
due to the whole industry growing
(particularly in a certain area)
External Economies
• Skilled Labour
• Suppliers and Ancillary Services
• Cooperation
How could each of these lead to decreased unit costs?
BUT…….
Sometimes larger businesses may suffer from
diseconomies of scale ……..
Cost Per Unit
Unit Costs- Graph
Economies of scale
Reducing unit costs
Diseconomies of scale
Outweighing economies
Lowest Unit Costs
Output
Question
• Why might ‘unit costs’ start to increase
again?
Diseconomies of Scale
• Where average unit costs rise as the
business grows larger
• Diseconomies of scale tend to occur
because it is more difficult to manage a large
business than a small one
Examples of Internal
Diseconomies of Scale
Bureaucracy
Poorer Labour relations
‘Small fish in a big pond’
Communication difficulties
Lack of Control and Coordination
Too much specialisation demotivates
workers
• Complacency
• How could these factors lead to an increase
in average unit costs?
•
•
•
•
•
•
External Diseconomies
• Land scarcity leading to increased rents
• Traffic congestion
• Pressure to increase wages to attract new
workers
IS GROWTH ALWAYS
DESIRABLE?
Questions…..
• Do all firms want to grow?
• Why do we still have small firms?
• What disadvantages might there be of being
a big firm?
Less
Paperwork
No motivation
to grow
New
Companies
Why do we still
have small firms?
Personal
Service
Lower Costs
Cost
Greater
Flexibility
Niche
Markets
Potential problems with growth
•
•
•
•
Increased costs
Liquidity problems (if growth is too fast)
Difficulties in communication/coordination
Diseconomies of Scale