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
, 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 specialist
s in various fields that are very skilled at what they do, rather than requiring more general manager
s. 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 employee
s 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.