Economies of Scale (Edexcel IGCSE Business): Revision Note

Internal and external economies of scale

• As a business grows, it is able to increases its scale of output

• This generates efficiencies that lower its average costs (AC) of production

  • These efficiencies are called economies of scale

  • Economies of scale help large firms lower their costs of production beyond what small firms are able to achieve

• Economies of scale can result in lower average (or unit) costs, not lower total costs

  • The total costs will increase, but at a decreasing rate per unit

Economies of scale and average costs

• With relatively low levels of output, the firms average costs are high

• As the firm increases its output, it begins to benefit from economies of scale which lower the average cost per unit

• The business will reach a level of output at which costs are minimised

• Beyond this point, diseconomies of scale will occur and the average cost will start to rise again

Internal economies of scale

• Internal economies of scale reduce average costs for a business when it grows

• Examples of internal economies include

  • Purchasing economies

    • Occur when large firms buy raw materials or components in greater volumes, allowing them to receive bulk purchase discounts

    • This reduces the average cost per unit and provides a cost advantage over smaller businesses that cannot buy in such large quantities

  • Managerial Economies

    • Happen when large firms can afford to employ specialist managers who are highly skilled and efficient at specific tasks

    • Greater managerial efficiency lowers the average cost

    • Additionally, large firms may attract top talent from other companies, further enhancing their competitive advantage

External economies of scale

• External economies of scale lower average costs for individual businesses when the market as a whole grows

• Examples of external economies include

  • Better-skilled workforce

    • A large and growing industry leads to an increased concentration of workers with industry-specific skills

    • These workers require less training and tend to be productive quickly following recruitment

    • Local educational institutions are likely to provide skills-based qualifications that are relevant to the growing industry

  • Improved infrastructure

    • A growing industry that employs many people is in a good position to persuade local authorities to improve transport and communications structure to meet its needs

    • This can make distribution more efficient and improves the effectiveness of business operations