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Edexcel IGCSE Business Your notes

Economies & Diseconomies of Scale

Contents
Economies of Scale
Diseconomies of Scale

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Economies of Scale
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Internal & External Economies of Scale
As a business grows, it is able to increases its scale of output
This generates efficiencies that lower its average costs (AC) of production
These efficiencies are called economies of scale
Economies of scale help large firms lower their costs of production beyond what small firms are
able to achieve

Economies of scale can result in lower average (or unit) costs, not lower total costs
The total costs will increase, but at a decreasing rate per unit
Diagram: Economies of Scale & Average Costs

Economies of scale lower average costs as the scale of output increases

Diagram analysis
With relatively low levels of output, the firms average costs are high

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As the firm increases its output, it begins to benefit from economies of scale which lower the average
cost per unit
The business will reach a level of output at which costs are minimised Your notes
Beyond this point, diseconomies of scale will occur and the average cost will start to rise again

Internal economies of scale

Internal economies of scale reduce average costs for a business when it grows
Economies of scale are generated by several internal factors, some of which the business has control
over
Two key internal economies of scale relate to purchasing and the ability of larger businesses to employ
specialist managers
Explanation of Purchasing & Managerial Economies of Scale

Type of Economy of Scale Explanation

Purchasing Economy Occurs when large firms buy raw materials or components in greater
volumes and receive a bulk purchase discount, which lowers the
average cost
This provides a cost advantage over smaller businesses

Managerial Economy Occurs when large firms can employ specialist managers who are
skilled and efficient at certain tasks, and this efficiency lowers the
average cost
They may attract the best talent from other businesses
increasing competitive advantage

External Economies of Scale

External economies of scale lower average costs for individual businesses when the market as a
whole grows

Examples of external benefits include

Better-skilled workforce
A large and growing industry leads to an increased concentration of workers with industry-
specific skills
These workers require less training and tend to be productive quickly following recruitment
Local educational institutions are likely to provide skills-based qualifications that are relevant
to the growing industry

Improved infrastructure
A growing industry that employs many people is in a good position to persuade local
authorities to improve transport and communications structure to meet its needs

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This can make distribution more efficient and improves the effectiveness of business
operations
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Exam Tip
When explaining economies of scale, make sure that you fully explain how each type lowers the
average costs for the business. This is different to only saying that is lowers the average cost. E.g. Bulk
purchases result in the business benefitting from cheaper raw materials, which lowers the cost per unit

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Diseconomies of Scale
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Diseconomies of Scale
As a firm continues increasing its scale of output, it will reach a point where its average costs (AC) will
start to increase
The reasons for the increase in the average costs are called diseconomies of scale
Diagram: Diseconomies of Scale & Average Costs

Diseconomies of scale occur when average costs increase with increasing output
Diagram analysis
At some level of output, a firm will not be able to reduce costs any further. This point is called
productive efficiency
Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale
This indicates that there is an optimal level of output that exists when the state of technology and
capital (machinery) is fixed

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Types of Diseconomies of Scale

Diseconomies of scale highlight that it is possible for a business to become so large that it becomes Your notes
less and less efficient

A business experiencing diseconomies of scale may reconsider its organisational structure to

improve communication and coordination problems
Many very large businesses often break themselves up into autonomous smaller units, which can
communicate more effectively

Explanation of Diseconomies of Scale

Type of Diseconomy of Scale Explanation

Poor communication & As a business increases in size, more managers and employees will join
coordination the business and the chain of command is likely to lengthen, limiting
interaction with employees

Communication becomes slower and mistakes may be made, leading

to worsening efficiency

Time-consuming decision-making may make it harder to coordinate

workers and physical resources

Increased bureaucracy Larger businesses are more complicated to run and organise than
small businesses

Coordinating the many resources required will require extensive

administration for which staff and physical resources will be required

Lack of commitment from As the business grows workers may feel less valued as their interaction
employees with management is limited

Workers may become demotivated leading to a fall in output which can

increase average costs

Exam Tip
Candidates frequently confuse economies and diseconomies of scale in exams. Make sure that you
can define both terms and give examples of why each could arise.

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