Economies of scale are the elements that contribute to the fall of the average production cost as the quantity produced increases. For instance, the cost of producing two hundred exercise books can be ten dollars, but the cost of producing four hundred exercise books is twelve dollars. It means that the average cost of producing two hundred exercise books is 0.05 dollars while that of producing four exercise books is 0.03 dollars. Economies of scale are of great importance for the efficiency of a firm.
What Are the Kinds of Economies of Scale?
Economies of scale can be internal or external.
Internal economies of scale are those factors that are from within the firm due to its increase in size. For example, the growth of the firm itself can be in terms of technical expertise, specialization, finance, and marketing. Here are some of the internal economies of scale:
Technical skills: Large-scale firms are in a position risk their capital in an expensive and specialist capital equipment. For example, well-developed and large retail stores can afford to purchase and install advanced Information Systems that can help them control their inventory, unlike the small ones.
Specialization: Large-scale firms divide various production stages into smaller portions that can be easily managed. It can improve production since a laborer specializes in a small area hence leading to high yield. It will, in turn, contributes to a good managerial advantage.
Marketing: Large-scale firms are in a position to cover a large area regarding advertisement and marketing. At this level, the average cost of advertisement is smaller as it is shared by a large volume of outputs unlike in small-scale firms whereby small production is bearing the cost of marketing. Also, the large firms can purchase their raw materials in large quantities that can enable them to negotiate low cost.
Financial: Large-scale firms have access to a broader pool of capital due to their creditworthiness. They can be subjected to low interest. Unlike the case of small-scale firms whereby most of them face difficulty in borrowing from banks and other financial institutions for fear of losing the money.
The external economies of scale, on the other hand, are the benefits that an organization gain from outside. They can be favorable government policies as well as the strong industry in which the firm is within, good infrastructure. The government policies can be low tax rates and subsidies that will lower production cost. The government can favor large-scale firms because they stand a good chance to solve a high percentage of unemployment to the citizens.
Well-developed infrastructure regarding roads, electricity, and communication will facilitate the transportation of raw materials and the required workforce to the firm. It will facilitate the processing of raw materials on time especially the perishable goods. Electricity can be used as the source of energy for propelling the machines and lighting.
What Are the Paybacks of Economies of Scale?
They enhance division of labor due to firm growth, which corresponds to increase in the output per worker in the firm. Also as the firm is growing, its lender does not doubt its creditworthiness hence the firm would be able to access loans at lower interest rates. Furthermore, the production cost is low with economies of scale since the cost of producing smaller quantities of goods is higher as compared to the cost of producing a larger volume of products.
What Are the Downsides of Economies of Scale?
There is lack of flexibility in economies of scale. Switching from one industry to another is difficult because it requires large capital investment for large-scale production. Besides, economies of scale might lead to overproduction. Firms can produce more than what is demanded hence forcing them to sell at lower costs.