Economies & Diseconomies of Scale (DP IB Business Management)
Revision Note
Written by: Steve Vorster
Reviewed by: Jenna Quinn
An Introduction to Economies & Diseconomies of Scale
As a business grows, it can increase its scale of output and generate efficiencies that lower its average costs (cost per unit) of production
These efficiencies are called economies of scale
Economies of scale help large firms to lower their costs of production beyond what small firms can achieve
As a firm continues increasing its scale of output, it will reach a point where its average costs (AC) will start to increase
The reasons for the increase in the average costs are called diseconomies of scale
Diagram: economies and diseconomies of scale
Diagram analysis
With relatively low levels of output, the businesses average costs are high
As the business increases its output, it begins to benefit from economies of scale which lower the average cost per unit
At some level of output, a business will not be able to reduce costs any further - this point is called productive efficiency
Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale
Examiner Tip
A common error made by students is asserting that production costs will fall as output increases. This is not correct.
As output levels increase, total production costs rise but, as a result of economies of scale and the costs of production being spread across more units of output, the average costs of production fall.
Internal Economies of Scale
Internal economies of scale occur as a result of the growth in the scale of production within the business
The firm can benefit from lower average costs (AC) generated by factors from inside the business
Types of Internal Economies of Scale
Type | Explanation |
---|---|
Financial economies |
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Managerial economies |
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Marketing economies |
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Purchasing economies |
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Technical economies |
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Risk bearing economies |
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External 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 can benefit from lower average costs (AC) generated by factors outside of the business
Sources of External Economies of Scale
Source | Explanation |
---|---|
Geographic Cluster |
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Transport Links |
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Skilled Labour |
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Favourable Legislation |
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Diseconomies of Scale
As a firm continues increasing its scale of output, its average costs per unit will start to increase at some point
The reasons for the increase in the average costs per unit are called diseconomies of scale
Types of Diseconomies of Scale
Diseconomies | Explanation |
---|---|
Management Diseconomies |
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Communication Diseconomies |
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Geographical Diseconomies |
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Cultural Diseconomies |
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