Economies of Scale (Edexcel IGCSE Business)

Revision Note

Lisa Eades

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

A diagram of economies of scale


 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

  • Occurs when large firms buy raw materials or components in greater volumes and receive a bulk purchase discount, which lowers the average cost

    • This provides a cost advantage over smaller businesses

Managerial Economy

  • Occurs when large firms can employ specialist managers who are skilled and efficient at certain tasks, and this efficiency lowers the average cost

    • They may attract the best talent from other businesses increasing 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 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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Lisa Eades

Author: Lisa Eades

Expertise: Business Content Creator

Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

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.