Understanding Economies of Scale

This assignment delves into the crucial concept of economies of scale within business operations. It defines economies of scale and outlines their various elements like production functions and input types (variable & fixed). The report highlights the significance of economies of scale for sustained competitiveness and achieving success in a market. It also examines different types of economies of scale, including internal and external factors like marketing advantages, workforce specialization, and infrastructure investments. Finally, the report illustrates how economies of scale contribute to economic growth and development with illustrative examples.

ECONOMIES OF SCALE

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
ECONOMIES OF SCALE – MEANING AND CONCEPT...........................................................1
TYPES OF ECONOMIES OF SCALE...........................................................................................3
EXAMPLE OF ECONOMIES OF SCALE....................................................................................4
ECONOMIES OF SCALE SHAPING THE ECONOMIC DEVELOPMENT..............................5
CONCLUSION................................................................................................................................5
REFERENCES................................................................................................................................7

INTRODUCTION
Economies of scale are the various advantages in cost that an organization obtains due to
the expansion within the scale of production in the long run. The impact of this is decreased
average cost in unit output as the scale increases. This refers to a long run concept related to a
reduced unit cost of manufacturing as the size of organization or scale of manufacturing
increases. This report will determine the various aspects of economies of scale and also identify
ways in which these economies of scale can shape the economic development of regions.
ECONOMIES OF SCALE – MEANING AND CONCEPT
The Economies of Scale are essential concepts in the global markets and international
trade. It assists in explaining the number of organizations in the marketplace and those which are
managing to trade in the global markets. A natural monopoly is an organization that enjoys
economies of scale in all the organizations and has no competition. The organizations having
natural economic conditions enjoy their power in the market and successfully avoid excessive
exploitation of their economies of scale. Economies of scale also relate to returns to scale but it is
a confusing concept. The economies of scale refer to organization's average costs whereas the
returns to scale refers to the relationship between input and output in the long run within the
manufacturing function.
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Illu
stration 1: Economies of Scale
Source: Economies of Scale, 2015].Available through:
<https://www.tutor2u.net/business/reference/economies-of-scale>
Economies of scale is a concept that arises in the context of manufacturing products or
services as well as other related operations undertaken by a business organization or a non-
business firm. Economies of scale refers to the efficiency of economy that results in carrying out
various processes such as sales or production on a large scale. The resulting economic efficiency
is generally measured in terms of costs involved because the scale of relevant activity increases.
In order to understand the concept of economies of scale, it is important to determine the various
concepts related to the process of production. These concepts or elements are discussed as
below-
 Production function and inputs – Production or manufacturing of a product is usually
based on technological relationship, the amount of various factors of production
functions are converted into products based on certain technological elements. This
technological relationship is called as the production function by the economists.
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According to more technical terms, the manufacturing or production function can be
called as the maximum output that a production company can generate with the help of
technology by the amount of input incurred in the production process. Price fluctuations
of other commodities in relation with global demand for these commodities acting as
indirect pricing. Commercial banks are choosing practice like money printing or gold
purchase and sale leading to increase in price of gold whole around the world.
 Using the best technology for a production procedure can positively affect productivity of
organization and also, increases the effectiveness and efficiency in the overall production
process or activity. The inputs utilized in a production process can generate maximum or
the best outputs by a better technology. There are different types of inputs which in the
production function of an organisation, these inpuits can be described as below-
 Variable and fixed inputs – Mainly, there are two inputs which are used in a production
process of an organization i.e. the fixed input and variable input. The fixed input can be
defined as the input or elements needed in the production process with a fix quantity or
amount. The changes in quantity of output does not have any effect on fixed input
within a production process. The factory shed or plan are few examples of the fixed
inputs. Variable inputs are elements which can be fluctuating according to the desired
output from a production process. In order to maximize or increase quantity of outputs
from a production process, an organization can increase the variable inputs which along
with fixed inputs can raise the level of output generated in a production process. Cost
related to the inputs both; variable and fixed are also a major concern of an organization
engaged in a manufacturing or production of goods(Turner and et.al, 2017).
 Average and total costs – A production company or organization focused on profit
maximization, identify and calculate the total cost of production for any provided output
level. The total cost consists of total variable and fixed cost. The total fixed cost remains
the same in the short run whereas the total variable cost can fluctuate. The firm needs to
calculate average cost by identifying the cost per unit. This average cost is made up of
two important components i.e. the average variable cost and the average total cost. The
average variable cost is calculated by dividing the total variable cost by the number of
units of the outputs whereas, the average fixed cost is calculated by dividing the total
cost by the units of output. As discussed earlier, the fixed cost remains constant over the
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short run, average fixed cost decreases with increase in the level of production. On the
other hand, variable cost first decreases and then increases. This is known as the U-
shaped nature of average variable cost(Carvalho and Marques, 2014). Real interest rates
and specially the one which is followed in the UK impacting the growth and overall
demand of gold in different countries. Individuals demand for gold for different purposes
and these demand only impact the price of the gold in the global market.
 Average cost and economies of scale – Economies of scale are generally defined in
terms of the average cost per unit of output manufactured. According to the situation
when the average cost is decreasing, the manufacturer of the goods or product is
obtaining efficiency outcomes due to economies of scale. Until and unless the average
cost of manufacturing or production is decreasing, organization has an advantage of
enhancing the level of output. Most of the organizations focus on being at the minimum
average cost, but in the short run, the organization may need to manufacture at an output
level which is higher than compared to the minimum average total cost of production.
Central banks of different countries keep their monetary assets either in the form of paper
currencies or reserves. From economics perspective, negative externalities are generally
the cost or benefit that affects a party who do not choose that cost or benefit.
TYPES OF ECONOMIES OF SCALE
There are two major types of Economies of Scale:
 Internal
 External Internal economies of scale – It occurs when an organization's efforts lead to cost
benefits. The internal economies of scale can occur through procedural, technical or
managerial changes such as new managers with special skills or new machinery.
Financial benefits can occur when big firms are capable to obtain loans at lower interest
rate as compared to smaller organizations(Oliver and et.al, 2015).There are many kinds of
internal economies of scale as described below -
1. Technical economies of scale – Large scale organization can afford in specialist and
expensive capital machinery. For example supermarket chains such as Sainsbury or
Tesco can easily invest in technology that can help in improving their stock control.
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2. Specialization of the workforce – Large organizations divide confusing or complex
manufacturing processes into different tasks or activities to improve and increase their
productivity.
3. Marketing economies of scale – A big firm can enhance its marketing and advertising
budget over a huge output and it can buy its inputs in bulk quantity at negotiated
discounter prices if it has effective negotiation power in the marketplace.
4. Managerial economies of scale – This is a type of division of labour, large-scale
production organizations recruit or hire specialists in order to supervise manufacturing
systems, oversee human resources and manage the marketing systems (Mithas and et.al,
2018).
5. Financial economies of scale – Large organizations are generally rated by the financial
markets to be much more credit worthy and have easy access to various credit facilities
along with favourable rates of borrowing. In order to prevail this negative externalities
and to achieve a socially efficient outcome, government have to impose some taxation
policy in order to meet these externalities and this will state that the consumer have to
pay the full social cost.
6. Network economies of scale – Network economies are effectively explained by saying
that the extra cost of adding one more user to the network is close to zero but the benefits
resulting may be huge as each new user to the network can trade or interact with all the
existing parts and members of the network (Hennebe and et.al, 2017)
 External economies of scale – It can occur when the organization's efforts of external
factors such as governments or other disorganization result in benefiting a company. For
example: if a new highway is constructed, it can decrease the cost of transportation for
company. The various examples of external economies of scale are described as below -
1. Investment by a local authority on the improvement of transport network for a local city
or town.
2. Development of research facilities in several businesses and local universities in a
beneficial area.
3. Relocation of component supplier and other support organizations close to the main
centre of production are also external cost saving.
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Economies of Scale works best when combined with other competitive advantages, in
short decline costs with increasing operational scale leads to economies of scale butnot all the
economies of scale are developed in this way.
EXAMPLE OF ECONOMIES OF SCALE1. Tap water (High fixed cost of a national network)- In order to produce tap water, the
water companies needs to make a great investment on large network of water pipes
spread all around a country. It has a high investment of the fixed cost but as they provide
water to millions of households, its average cost decreases. This an example of natural
monopoly.2. Specialization – Car production – The other economy of scale is in the manufacturing of
a complex product like a motor car. The manufacturing process consists of various
complex stages. Hence, in order to manufacture a car, organisation needs to split their
production process and also requires employees skilled in producing different parts of the
car (Donaldson and et.al, 2017).
3. Bulk Buying – Supermarkets – The supermarkets can also get a huge benefit from
economies of scale as they can purchase food in bulk and gain lower average costs. For
example: if the organization has a delivery of only 100 cartons of mild, the average cost
will be very high, the marginal cost for delivering 10000 cartons will be low. The
organization needs to pay only one driver the cost for fuel will be the same. It is obvious
that the organization will require a bigger van but the average cost of transporting 10000
cartons will be very less as compared to that of 100 cartons.
ECONOMIES OF SCALE SHAPING THE ECONOMIC DEVELOPMENT
According to the above examples, it can be analysed that the economies of scale
encourage or motivate the organization to increase their productivity and profitability effectively.
There are various organisations that effectively controls and manages their costs, inputs,
resources and workforce to generate the best outcomes from a production process. Controlling or
managing the cost and production activities different organizations can achieve optimum
utilization of resources in the production process which helps in generating maxim um outputs at
a minimum or reasonable cost. Economies of scale greatly assist the organization to develop a
balance between the cost, inputs and activities according to the desired outputs in the production
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functions in order to achieve the organizational goals or objectives. It helps in increasing the
profitability leading to the growth and development of overall economy of the country or region
(Atack, 2018).
CONCLUSION
The above report concluded that economies of scale are important to be understood by
each and every organization or business operating at both large and small scale. The detailed
concept of economies of scale is described in the report along with the various elements of the
economies of scale such as production function and inputs, variable and fixed inputs, etc. which
helps to determine that in order to sustain in competitive market or achieve success economies of
scale needs to be considered. The report also determined the role of various types of economies
of scale such as internal and external economies of scale on a business or organisation. For
example marketing economies of scale, Specialization of the workforce, Investment by a local
authority on the improvement of transport network for a local city or town etc. Furthermore, the
report also determined the way in which economies shaping the economic development and
growth with suitable examples.
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REFERENCES
Books and Journals
Atack, J. (2018). Estimation of economies of scale in nineteenth century United States
manufacturing (Vol. 5). Routledge.
Donaldson, D., Costinot, A., Rodriguez-Clare, A., & Bartelme, D. (2017). Sector-Level Economies of
Scale: Estimation Using Trade Data. In 2017 Meeting Papers (No. 1643). Society for Economic
Dynamics.
Mithas, S., Han, K., & Krishnan, M. S. (2018, January). On the Economies of Scale and Budget
Allocations in Information Technology Services Provision. In Proceedings of the 51st Hawaii
International Conference on System Sciences.
Hennebel, V., Simper, R., & Verschelde, M. (2017). Is there a prison size dilemma? An empirical analysis
of output-specific economies of scale. European Journal of Operational Research, 262(1), 306-
321.
Carvalho, P., & Marques, R. C. (2014). Computing economies of vertical integration, economies of scope
and economies of scale using partial frontier nonparametric methods. European Journal of
Operational Research, 234(1), 292-307.
Turner, H. C., Toor, J., Hollingsworth, T. D., & Anderson, R. M. (2017). Economic evaluations of mass
drug administration: The importance of economies of scale and scope. Clinical Infectious
Diseases.
Oliver, M. E. (2015). Economies of scale and scope in expansion of the US natural gas pipeline
network. Energy Economics, 52, 265-276.
Online
[Economies of Scale, 2015].Available through:
<https://www.tutor2u.net/business/reference/economies-of-scale>
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