Economies of Scale
1. Define and explain all Internal Economies of Scale:
· Internal Economies of Scale:Are reductions in long-run average cost
as the size and output of a firm increases. In other words, they are
advantages that large firms have because they are large. As they grow
larger in the long-run they manage to raise their output faster than
the rise in their total costs. The result is lower long-run average
- Marketing economies- Both in buying materials and selling its
finished goods a large firm is n a better position than a smaller one.
In buying the products it needs, the large firm often pays less for
raw materials, machinery and so on because suppliers are sure they are
going to get large orders and do not want to lose a big customer. E.g.
A producer of shoelaces will sell its products for â‚¤1 per packet to
Nike because it has an order of 1000 packets per week. But for Adidas
it will sell them â‚¤2 because it has only an order of 100 packets per
week. So Nike has a lower cost per packet compare to Adidas.
In selling its products, Nike can afford to pay for expensive and
professionally made advertisements or employ specialist salesmen much
easier than Adidas. The large total cost of advertising can be spread
over a large output that is sold. Therefore, the average cost of
advertising will be low.
- Financial economies- If Nike is going to borrow money because it is
a well known firm, it is considered more reliable, and less risky is
easier to borrow than Adidas. So Nike can borrow a large amount of
money with a lower interest rate compared to Adidas. E.g. If Nike
borrows â‚¤1, 000000 it will pay an 8% interest rate while if Adidas
borrows â‚¤1,000 it will pay a 10% interest rate. So the average cost of
borrowing money for Nike is much smaller compared to Adidas.
- Managerial Economies- Large firms are able to pay high salaries to
employ professional managers who are trained specialists in various
areas and this brings the advantages of division of labour, and each
job will be done better by the trained expert. Since the larger
advantage of division of labour is the increase in output, the large
firm's rise in total output is greater than its rise in total cost
from employing the specialists. So the average cost falls.
2. Define and explain all Internal Diseconomies of Scale:
· Internal Diseconomies of Scale: Are increases in long-run average
cost as the size and output of a firm increases too much. Although
firms benefit from Internal Economies of Scale by becoming larger,
there is a point where a firm may become too large and as a result
average cost may begin to rise. The advantages of Internal Economies
of Scale are lost by the disadvantages of Internal Diseconomies of
- Managerial Diseconomies- Many managers can be an advantage but
having to many can make the organization of production very
complicated and more costly. Too many...