Economies of Scale refer to the cost advantage that a firm experiences when it increases its output level. In other words, it is the advantage that large quantities have over smaller ones. This is due to the fact that when large quantities are produced, businesses can reduce their fixed costs, leading to lower per unit costs.
According to the characteristics and particularities of the company and industry, economies of scale fall into two categories, the internal and external economies of scale.
1. Internal economies of scale
These are the economies of scale that are unique to the firm and they fall into categories below:
2. External economies of scale
On the other hand, external economies of scale are those that lie within the entire industry. This is often seen when governments play a role in that particular industry, such as through regulation and law. External economies of scale are usually enjoyed by big companies due to their scale of size and ability to influence the industry.
Diseconomies of scale
As firms get bigger, the complexity of their operation increases and firms often expand beyond the optimal size. This in turn may lead to rising Long Run Average Cost (LRAC), leading to diseconomies of scale. For this reason, it is important that firms control their output and extent of operation so that it does not turn into diseconomies of scale. If this is the case then the firm is becoming less efficient and additional costs start to arise. Some examples seen in this scenario are:
The concept of economies of scale does not only apply to the business world- it is a phenomenon seen in our everyday lives. Taking a simple example of grocery shopping – buying in bulk is much cheaper on the long term due to bulk offers and fewer trips to the store. Therefore, the next time you are shopping take this into account and remember the economies of scale concept!