Outline briefly- with a diagram, the key economies and diseconomies of scale, both internal and external. How useful is the whole concept of Economies of Scale?

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ECONOMICS ESSAY

ECONOMIES AND DISECONOMIES OF SCALE

QUESTION: outline briefly- with a diagram, the key economies and diseconomies of scale, both internal and external. How useful is the whole concept of Economies of Scale?

Economies of scale: a basic introduction

Economies of scale in simple words are the cost advantages of a business (the money it saves) when it expands. As we know, a company has two main costs: fixed cost and variable cost. When it increases its fixed costs to expand the business, its efficiency and production increases, and the costs incurred are shared by the increased number of goods, thus lowering the average cost per good. In simpler words…economies of scale is the situation of a company when its average costs per unit decrease due to an increase in production. One benefit of such a situation is that due to lower costs of production, the monetary burden on the consumer decreases, thus enabling the company to increase its market share. An alternative is if the company wants to maintain its current prices. The advantage here is that it can benefit from larger profit margins. For example: a soft-drink company can produce 100 bottles of the drink a day at a total cost of Rs. 3000. Thus the average cost per unit is (3000/100) = Rs. 30. The company then imports a machine costing Rs. 2500 which increases the rate of production. Now, in the same Rs. 3000, it can produce 150 units of the soft-drink. Now, the average cost per unit becomes 3000/150 = Rs. 20. As seen, the average cost per unit has decreased by Rs.10. Here we can say that the company has succeeded in achieving economies of scale. What about the Rs. 2500 incurred in machinery? In the short run, though it may appear as if costs have risen due to extra investment, it is only a one-time investment and will lead to increased production and efficiency, and decreased costs per unit in the long run.

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Looking at it differently, we can rightly say that by achieving economies of scale, the company has better chances to decrease its cost. According to Adam Smith, there are two ways to achieve economies of scale, i.e. two ways to achieve larger returns on production: division of labour and specialisation. Other ways to achieve economies of scale are i) lowering cost inputs by taking advantage of volume discounts (average costs are less when you buy in bulk), ii) costly inputs such as spending more on advertising, increasing research and development, and improving management, iii) specialized inputs, such as specialized machinery ...

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