Economies & Diseconomies of Scale (Cambridge (CIE) O Level Economics)

Revision Note

Written by: Steve Vorster

Reviewed by: Jenna Quinn

As a firm grows, it is able to increases its scale of output generating efficiencies that lower its average costs (AC) 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 are able to 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
Internal economies of scale occur as a result of the growth in the scale of production within the firm

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
At some level of output, a firm 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

Types of Internal Economies and Diseconomies of Scale

Internal Economies of Scale	Diseconomies of Scale
Financial Economies Managerial Economies Marketing Economies Purchasing Economies Technical Economies Risk-bearing Economies	Management Diseconomies Communication Diseconomies Geographical Diseconomies Cultural Diseconomies

External economies of scale occur when there is an increase in the size of the industry in which the firm operates
- The firm is able to benefit from lower average costs (AC) generated by factors outside of the firm

Sources of External Economies of Scale

Source	Explanation
Geographic Cluster	As an industry grows, ancillary firms move closer to major manufacturers to cut costs and generate more business This lowers the AC e.g. car manufacturers in Sunderland rely on the service of over 2,500 ancillary firms
Transport Links	Improved transport links develop around growing industries in order to help get people to work and to improve the transport logistics This lowers the AC e.g. Bangalore is know as India's Silicon Valley and transportation projects have been successful in transforming the movement of people and goods
Skilled Labour	An increase in skilled labour can lower the cost of skilled labour, thereby lowering the AC The larger the geographic cluster, the larger the pool of skilled labour
Favourable Legislation	This often generates significant reductions in AC as governments support certain industries in order to achieve their wider objectives

Last updated: 27 June 2024

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