Economies of Scale (Edexcel IGCSE Business)
Revision Note
Written by: Lisa Eades
Reviewed by: Steve Vorster
Internal & 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
Diagram: Economies of Scale & Average Costs
Economies of scale lower average costs as the scale of output increases
Diagram analysis
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
Economies of scale are generated by several internal factors, some of which the business has control over
Two key internal economies of scale relate to purchasing and the ability of larger businesses to employ specialist managers
Explanation of Purchasing & Managerial Economies of Scale
Type of Economy of Scale | Explanation |
---|---|
Purchasing Economy |
|
Managerial Economy |
|
External Economies of Scale
External economies of scale lower average costs for individual businesses when the market as a whole grows
Examples of external benefits 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
Examiner Tips and Tricks
When explaining economies of scale, make sure that you fully explain how each type lowers the average costs for the business. This is different to only saying that is lowers the average cost. E.g. Bulk purchases result in the business benefitting from cheaper raw materials, which lowers the cost per unit
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