This video explains how economies of scale affect production. We start by explaining how the average cost curve defines when economies of scale appear, and then analyse the difference between economies and diseconomies of scale.
This economic phenomenon occurs when increasing output is translated into a decline of the firm’s average cost of production. Alfred Marshall was the first economist to distinguish economies of scale depending on their origin:
Internal economies of scale occur when something inside the firm makes the average cost of production lower:
- Purchasing: buying raw materials in large quantities or big bulks brings better prices and discounts which allow average cost to be reduced.
- Specialisation: covering all areas of management and work can be very difficult, however when operating on a large scale, workers can specialize in the activities in which they are best and more productive.
- Flexibility: a more efficient production process can be achieved by managers when scale means that different arrangement of the inputs can be made. Better capital can be purchased by firms that have more money, increasing the quality of their products and/or reducing cost of production.
External economies of scale occur when something outside the business, but inside its industry, makes average cost of production lower. As the industry of the firm grows, more support may come from the suppliers’ side: more variety, more quality, more quantity, etc. Government may give extra aid if it considers that the industry has some special interest.
Learn more by reading the dictionary entry.