Overview of Economies of Scale
– Economies of scale refer to cost advantages obtained by enterprises due to their scale of operation.
– They can be measured by the amount of output produced per unit of time.
– Economies of scale can be achieved through factors such as purchasing, managerial, financial, marketing, and technological advantages.
– They help explain why companies grow large in certain industries and justify free trade policies.
– There are two types of economies of scale: internal and external.
Determinants of Economies of Scale
– Physical and engineering basis: economies of increased dimension are based on the square-cube law and result in lower capital costs and energy savings.
– Economies in holding stocks and reserves: larger scale leads to smaller reserves needed to cope with unforeseen contingencies.
– Transaction economies: larger scale allows for greater bargaining power over input prices and benefits in terms of purchasing raw materials.
– Economies deriving from the balancing of production capacity: larger scale enables more efficient use of productive capacity.
Limits of Economies of Scale
– There are limits to economies of scale, such as exceeding the nearby raw material supply or saturating the regional market.
– Large producers may find it costly to switch to specialty grades, while smaller facilities can remain viable by producing specialty products.
– Passing the optimum design point can lead to increased costs per additional unit.
– Inefficient energy use or higher defect rates can also limit economies of scale.
Historical Context of Economies of Scale
– The concept of economies of scale dates back to Adam Smith and the idea of obtaining larger production returns through division of labor.
– Nicholas Georgescu-Roegen and Nicholas Kaldor have also contributed to the understanding of economies of scale.
– The concept has been applied to explain patterns in international trade and the number of firms in a given market.
– Economies of scale play a role in natural monopolies.
– They must be distinguished from economies resulting from an increase in the production of a given plant.
Examples and Applications of Economies of Scale
– Examples of economies of scale include bulk buying of materials, specialization of managers, lower-interest charges when borrowing, spreading advertising costs, and taking advantage of returns to scale in production.
– Some industries exhibit internal economies of scale, where costs decrease when the number of firms in the industry drops.
– External economies of scale occur when costs decrease due to the introduction of more firms, allowing for more efficient use of specialized services and machinery.
– Economies of scale exist when a single firm can produce two quantities of a product at a lower total cost than two separate firms. Source: https://en.wikipedia.org/wiki/Economies_of_scale
In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of time. A decrease in cost per unit of output enables an increase in scale. At the basis of economies of scale, there may be technical, statistical, organizational or related factors to the degree of market control. This is just a partial description of the concept.
Economies of scale apply to a variety of the organizational and business situations and at various levels, such as a production, plant or an entire enterprise. When average costs start falling as output increases, then economies of scale occur. Some economies of scale, such as capital cost of manufacturing facilities and friction loss of transportation and industrial equipment, have a physical or engineering basis.
The economic concept dates back to Adam Smith and the idea of obtaining larger production returns through the use of division of labor. Diseconomies of scale are the opposite.
Economies of scale often have limits, such as passing the optimum design point where costs per additional unit begin to increase. Common limits include exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry. A common limit for a low cost per unit weight commodities is saturating the regional market, thus having to ship products uneconomic distances. Other limits include using energy less efficiently or having a higher defect rate.
Large producers are usually efficient at long runs of a product grade (a commodity) and find it costly to switch grades frequently. They will, therefore, avoid specialty grades even though they have higher margins. Often smaller (usually older) manufacturing facilities remain viable by changing from commodity-grade production to specialty products.
Economies of scale must be distinguished from economies stemming from an increase in the production of a given plant. When a plant is used below its optimal production capacity, increases in its degree of utilization bring about decreases in the total average cost of production. As noticed, among the others, by Nicholas Georgescu-Roegen (1966) and Nicholas Kaldor (1972) these economies are not economies of scale.
