What is it ? And what are its types ? What are its pros and cons?

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Economies of scale occur when increased production leads to lower average costs in the long run. This means that as companies get larger, they become more efficient.

What are economies of scale?

Economies of scale are the cost advantages that can occur when a company increases its production volume and becomes more efficient, resulting in a lower cost per unit.

This is because the cost of production (including fixed and variable costs) is spread over more units of output.

Economies of scale provide larger firms with a competitive advantage over smaller firms, because the larger the business, the lower the unit costs.

An example of economies of scale
A common example of economies of scale in business is seen when looking at large supermarket chains versus independent grocers.

With larger chains of cash in bank and more customers, they can buy a large quantity of groceries from suppliers, resulting in a lower unit cost, compared to stand-alone stores.

This is why it is cheaper to do your weekly shopping in a large chain than in a small business.

What are the different types of economies of scale?

There are two main types of economies of scale – external and internal.

1. External economies of scale

External economies of scale depend on external factors. Anything that enables a company to reduce costs can be considered a broad external economy, including tax cuts, government subsidies, an improved transportation network, or a pool of skilled workers.

2. Internal economies of scale

The internal economies of scale are controlled by the company. They can occur any time a company cuts costs, from buying in bulk andinvestment In state-of-the-art machinery, access to additional financial capital and the employment of a specialized workforce.

3. Technical economies of scale

Technical economies of scale are a type of internal economy of scale. It is the economies of scale achieved via technology. This means that larger companies have capital to invest in newer and better technology, which can provide them with cost advantages that smaller companies cannot.

4. Purchasing economies of scale

Purchasing economies of scale, also called purchasing economies of scale, is a type of internal economies of scale. It is the economies of scale achieved by buying in bulk. And

This means that large firms have the cash and output more easily to ensure that materials are purchased in much larger quantities, which can bring them cost-per-unit advantages that smaller firms cannot achieve otherwise.

5. Economics of financial scale

Financial economies of scale are a type of internal economy of scale. It is the economies of scale that enable more favorable borrowing rates. This means that larger companies are viewed by lenders as more reliable or creditworthy due to their size, while smaller companies tend to pay higher interest rates.

Advantages of economies of scale

The benefits of economies of scale to industries and businesses are wide-ranging, but in general, they enable large firms to reduce their costs, pass the savings on to the consumer, and gain an advantage over the competition. So, what are the advantages of economies of scale?

  1. Lower long-run unit costs One of the main benefits of internal economies of scale is cost reduction, which enables companies to improve their price competitiveness in global markets.
  2. increase profits – Economies of scale increase profits, generate a higher return on capital investment and provide companies with a platform for growth.
  3. Larger scope of work As the business grows in size, it strengthens and becomes less vulnerable to external threats, such as hostile takeover offers. This is one of the main benefits of economies of scale for industries as it has a positive effect on a company’s stock price, as well as their ability to raise new financing.

Of course, there are also plenty of benefits of economies of scale for consumers, as lower unit costs often result in lower prices. What are the advantages of economies of scale for consumers?

  1. prices drop – A lower cost per unit leads to lower prices for the consumer, which means that, in general, consumers will have higher real incomes and easier access to affordable products.
  2. Product improvements – Companies can reinvest their capital savings into research and development, resulting in better products (such as cheaper medicines and food).
  3. higher wages For employees, another major benefit of economies of scale is the potential for profit sharing and an increase in real wages due to cost savings.

Disadvantages of economies of scale

When a business becomes very large, its unit costs may start to rise. This is referred to as a lack of economies of scale, and it is a major drawback that growing companies must watch out for. Lack of economies of scale can be caused by a number of different factors, including:

poor communication – Ineffective communication, where it becomes difficult to coordinate a large workforce as your company grows, is one of the main factors behind a lack of economies of scale.

loss of control – As the business grows, it becomes increasingly difficult to monitor the productivity and quality of thousands of employees, which leads to inefficient production processes.

duplication of efforts Duplication of effort can also be a problem, with more than one person ending up in the same job or task.

demoralized – As companies become larger, employees are likely to feel distant and develop a sense of alienation, which can lead to lower productivity and waste.

external opposition – Behavior that would have gone unpunished in a smaller company is more likely to be seen as a threat as the business gets larger, leading to public and government opposition.

In addition, the benefits of internal economies of scale to consumers may not be as impressive as they seem. For a start, economies of scale may not always lead to lower prices, because the dominant firms may simply form a monopoly and charge higher prices.

It is also worth remembering that the environmental consequences of mass production can be significant, from pollution to electronic waste.

Final words

While there are some disadvantages associated with economies of scale, these can be avoided by focusing more on management and communications. And while large companies can take advantage of the benefits of economies of scale more effectively, even start-ups and small businesses can benefit.

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