Economies & Diseconomies of Scale (Edexcel IGCSE Economics)

Revision Note

Written by: Steve Vorster

Reviewed by: Jenna Quinn

As a firm grows, it is able to increase its scale of output generating efficiencies, that lowers its average cost of production (AC)
- These efficiencies are called economies of scale
- Economies of scale help large firms lower their production costs beyond what small firms are able to achieve
As a firm continues to increase its scale of output, it will reach a point where its average costs (AC) will start to increase
- The reasons for the increase in average costs are called diseconomies of scale

With relatively low levels of output, the firm's 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
At some level of output, a firm will not be able to reduce costs any further; at this point the firm achieves its greatest efficiency
Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale

Internal economies of scale occur as a result of the growth in the scale of production within the firm

Types of Internal Economies of Scale

Internal Economy of Scale	Explanation
Purchasing	This occurs when large firms buy raw materials in greater volumes and receive a bulk purchase discount, which lowers the AC
Managerial	It occurs when large firms can employ specialist managers who are more efficient at certain tasks, and this efficiency lowers the AC Managers in small firms often have to fulfil multiple roles and are less specialised
Marketing	Large firms spread the cost of advertising over a large number of sales, and this reduces the AC They can also reuse marketing materials in different geographic regions, which further lowers the AC
Financial	Large firms often receive lower interest rates on loans than smaller firms, as they are perceived as less risky A cheaper loan lowers the AC
Technical	Occur as a firm is able to use its machinery at a higher level of capacity due to the increased output Thereby spreading the cost of the machinery over more units and lowering the AC
Risk bearing	It occurs when a firm is able to spread the risk of failure by increasing its numbers of products Leads to greater product diversification; less failure lowers AC

As a firm continues to increase its scale of output in the long-run, external changes will occur in the locality and in the industry that will help to lower the firm's average costs (AC)

Sources of External Economies of Scale

Source	Explanation
Skilled labour	As the firm grows, local educational establishments will provide relevant qualifications to that industry The firm can employ workers who are already skilled, saving on training costs
Infrastructure access	Local authorities may build access roads near large firms to ease delivery vehicle and shift worker traffic
Local suppliers	Key suppliers may relocate to be near their largest customer to cut delivery costs and lead times
Similar businesses are in the area	As a firm grows, other similar businesses relocate to this area to take advantage of the external factors that lower AC

Internal diseconomies of scale occurs when an increase in the scale of output results in a higher cost per unit due to factors generated inside of the business

Types of Internal Diseconomies of Scale

Bureaucracy	Large firms have significant amounts of paperwork, rules and regulations This slows down decision making and production, raising AC
Communication	Accurate communication breaks down when large numbers of workers are involved, leading to inaccuracies and confusion, raising AC
Control	Large numbers of workers and many product lines become difficult to control A lack of coordination between aspects of production can raise AC
Distance between management and workers	A large firm is likely to have many layers of hierarchy Messages are miscommunicated and misinterpreted through the layers, raising AC

Last updated: 10 June 2024

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