Economies & Diseconomies of Scale (Edexcel A Level Economics A)
Revision Note
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.
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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