Economies & Diseconomies of Scale (Edexcel A Level Economics A)

Revision Note

Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Economies & Diseconomies of Scale

  • As a firm increases its scale of output in the long-run, its long-run average total costs (LRATC) will initially decrease due to the benefits it receives

    • These benefits are called economies of scale

      • During this period the firm is enjoying increasing returns to scale

  • As a firm continues increasing its scale of output in the long-run, its LRATC will start to increase at some point

    • The reasons for the increase in the LRATC are called diseconomies of scale

      • During this period the firm is facing decreasing returns to scale

Types Of Economies and Diseconomies of Scale

Economies of Scale

Diseconomies of Scale

Financial Economies

Management Diseconomies

Managerial Economies

Communication Diseconomies

Marketing Economies

Geographical Diseconomies

Purchasing Economies

Cultural Diseconomies

Technical Economies

 

Risk-bearing Economies

 

Minimum Efficient Scale

  • The minimum efficient scale is the lowest cost point on a long-run average total cost (LRATC) curve

    • It represents the lowest possible cost per unit that a firm in the industry can achieve in the long run.

3-3-3-minimum-efficient-scale_edexcel-al-economics
As a firm grows, economies of scale help a firm to reach its minimum efficient scale before diseconomies raise the cost/unit again

Diagram analysis

  • Each subsequent short-run average cost (SRAC) curve represents growth and an increase in size

    • Output increases with each period of growth

  • Initially firms experience increasing returns to scale as a result of the economies of scale

  • At a certain level of output, the firm will reach the minimum efficient scale where it experiences constant returns to scale

  • If it continues to grow beyond that level of output the firm will experience decreasing returns to scale as diseconomies of scale occur

Internal & External Economies of Scale

  • All of the economies of scale explained above are internal economies of scale

  • External economies of scale occur when there is an increase in the size of the industry in which the firm operates

    • The firm is able to benefit from lower LRATC generated by factors outside of the firm

Sources Of External Economies Of Scale

Source

Explanation

Geographic Cluster

As an industry grows, ancillary firms move closer to major manufacturers to cut costs and generate more business. This lowers the LRATC e.g. car manufacturers in Sunderland rely on the service of over 2,500 ancillary firms

Transport Links

Improved transport links develop around growing industries in order to help get people to work and to improve the transport logistics. This lowers the LRATC e.g. transport links around the M4 Corridor Tech Area between Reading and Bracknell have experienced significant improvement

Skilled Labour

An increase in skilled labour can lower the cost of skilled labour, thereby decreasing the LRATC. The larger the geographic cluster, the larger the pool of skilled labour

Favourable Legislation
 

This often generates significant reductions in LRATC as governments support certain industries in order to achieve their wider objectives e.g the animation cluster in Bristol and Bath is growing due to the tax incentives offered to the industry by the Government

Examiner Tips and Tricks

Diminishing marginal returns are the reason for the shape of the short-run cost curves. Economies and diseconomies of scale are the reason for the shape of the long-run cost curves. Students often get their language confused on this theory. Increasing and decreasing returns to scale only happen in the long run. Increasing and diminishing marginal returns only happen in the short run. 

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Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

Jenna Quinn

Author: Jenna Quinn

Expertise: Head of New Subjects

Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.