Economies of Scale: Theoretical Overview and Real-life Application

Running head: ECONOMICS ASSIGNMENT
Economics Assignment
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Introduction
Over the years, the economic patterns in the global scenario have undergone
significant dynamics and changes owing to the increasing integration and inclusiveness of the
economies of the countries across the different parts of the world. Much of these dynamics in
the economic activities can be attributed to the international phenomena like Globalization
and Liberalization of most of the economies and their commercial sectors, which have helped
in setting up commercial relations between different countries (Holland, 2018). Trade has
developed with time, which in turn has led to development and flourishment of different
industries in different countries and has helped in making different businesses going global.
There are several factors which have considerable implications on these production
and trading activities of the nations, thereby having visible impacts on the development of the
economies of these countries. One of such factors of considerable importance is popularly
known as the concept of “Economies of Scale” in the theoretical framework of economics
(Polkinghorn, 2016). Taking this into consideration the concerned essay tries to discuss the
concept of economies of scale in the light of the theoretical framework of economics, thereby
discussing the real-life application of the same in the global economic scenario and the
contribution of the same in the economic growth and development of different regions across
the world with time.
Economies of Scale: Theoretical Overview
As discussed above, economics, as a separate domain itself, has considerable
relevance and implications on the real life economic scenarios of the world as a whole and on
the countries in specific. One of such economic principle is known as the “economies of
scale”. There exist different explanations and definitions of the term, which have also
changed with time. However, the most comprehensive explanation of the term is that it refers

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to the advantages in terms of cost of production, which a producer or a firm enjoys with
increase in the level of output with time (Carlino, 2012).
To understand the concept of economies of scale and how it works it is important to
know about the structure of the cost of production of goods and services which is usually
incurred by the company. There are usually two types of costs incurred by a firm while
carrying out the production activities (Baumol & Blinder, 2015). These costs are:
Fixed cost- There are several costs which are incurred by the producers in their production
process, which do not depend on the number of units of output produced by the company.
These costs remain constant usually though a relevant range of production. Examples of such
costs are rent, machineries, plants and similar other factors of production.
Variable cost- These costs incurred by the firms in their production processes depend on the
number of units of output produced by the firms. In general, the variable cost of production
increase with the increase in the production of outputs, the rate of change varying with time.
The primary examples of variable costs of production are those of wages, cost of buying
intermediate materials and inputs required for production, utilities and similar commodities
(Hall & Lieberman, 2012).
Therefore, total cost of production of goods and services can be shown as follows:
Total Cost (TC) = Total Fixed Cost (TFC)+Total Variable Cost (TVC)
Thus, as the producers start with their production activities, initially the fixed cost of
production may seem to be high in many cases. However, with the increase in the number of
units of output, the average fixed cost goes on decreasing (Harrison, 2017). This can be
shown with the help of the following formula:
Average Cost of Production (AC) = Total Cost (TC)/Total Quantity (Q)

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Therefore, AC = (TFC/Q) + (TVC/Q)
AC = AFC + AVC
With the increase in Q, TFC remining constant, (TFC/Q) decreases which implies that
there is a reduction in the average fixed cost of production. The greater the quantity of output
which is produced by the suppliers, the lower is the average fixed cost of production. This
inverse relationship between the production of output and the average fixed cost of
production gives rise to an advantage in the cost of production, which is known as the
“Economies of Scale” in the conceptual framework (Rader, 2014). Often, with the increase in
production, the average variable costs of production also decrease, owing to the acquired
efficiencies in the operational framework with time. Thus, together these factors lead to fall
in the average cost of per unit of output with the increase in the production of output. This
phenomenon is known as economies of scale or increasing returns to scale in production
(Varian, 2014). This can be shown with the help of the following figure, showing the
dynamics in the long run average cost of production of the companies:
Figure 1: Economies of Scale in Long Run
(Source: As created by the author)