Economies of scale are
decreases in cost as a direct result of
increase in volume. There are several types of
internal economies of scale.
Technical economies of scale
When a
company is large enough to
purchase and
run bigger,
better, more
efficient and more
costly machinery. With this
bigger machinery that can output a lot more, they can begin
mass production at a lower running cost. This generally only works when a product is
standardized enough for long production runs.
Managerial economies of scale
When a firm is large enough to hire
specialists in various fields that are very skilled at what they do, rather than requiring more
general managers. These specialists can then aim to reduce costs by applying their expertise to the company.
Marketing economies of scale
These occur when a firm is large enough to employ
mass marketing strategies, such as TV advertising.
Financial economies of scale
An example of a financial economy of scale (thanks
Jurph) would be a payroll department with five
employees capable of doing
payroll for 1 million other employees. If a company has all million employees, they are working at maximum efficiency and therefore save money.
Risk-bearing economies of scale
If a company is big enough to
stomach the risk of
diversifying, then it can
diversify so much that it can be sure not
all of its enterprises will fail.
As you can see, all of the above require a fairly big capital injection initially, but should provide more benefit in the long run. This is the principle of economies of scale.
The average total cost is used to analyse economies of scale. Average total cost is cost per unit divided by output. If there are economies of scale to be reaped, ATC will fall as output rises. If ATC rises as output rises, the company is experiencing diseconomies of scale, meaning it has gone beyond its optimum size.