Economies and diseconomies of scale.

Economies and Diseconomies of scale and long run average cost.

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13.11.12 Rebeca Lucy
Economies of scale and long run average cost.
All factors of production are variable; this affects cost as output changes.
To start, long run costs fall as output increases, these are economies of scale.
As firms expand in size and output, their long run average costs tend to fall, at some point long run average
costs become constant.
However, some firms become too large and their average costs begin to rise
­ they experience diseconomies of scale.
Sources of economies of scale
Technical economies
o Economies and diseconomies of scale can exist because of increasing and decreasing
returns to scale, due to what happens in the production process.
o When firms find that they need equipment but are unable to make maximum use of it, this
is called indivisibility.
o Technical economies arise too because larger plant size is often more productively efficient.
Managerial economies
o Specialisation is important for efficiency and can therefore lead to lower costs.
o Small firms don't employ specialist staff because staff often represent an indivisibility.
Purchasing and marketing economies
o Larger firms usually buy raw materials in bulk, enables them to secure
lower prices for their factor inputs.
o Larger firms also have lower average costs from their marketing operators.
o A 30 second TV ad for a product which has sales of £10 million per annum costs the same as
a 30 second ad for a product with has sales of only £5 million per annum.
Financial economies
o Small firms struggle to raise finance for new investment, they are charged high interest rates
because they are at higher risk of bankruptcy than large firms
o Large firms have much greater choice of finance and it is likely to be much cheaper.
Diseconomies or scale
Arise mainly due to management problems; as firms grow larger they become more difficult to
manage and organise. Some companies choose to centralise operations with a small team controlling all
activities or the founder of the company overseeing all major decisions. In other companies, management
is delegated to small subsidiary companies making decisions about their part of the business and only head
office making decisions which affect the whole company.
Geography too may lead to higher average costs, if a company has to transport goods over long
distances, as the price of fuel rises, so will their average costs.


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