Economies & Diseconomies of Scale (Cambridge International IGCSE Economics)
An introduction to economies and diseconomies of scale
Spec point — "how internal and external economies and diseconomies of scale can affect a firm/industry as the scale of production changes"
An introduction to economies and diseconomies of scale
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Economies of scale occur when an increase in the scale of output results in a lower cost per unit
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As a firm grows, it is able to increases its scale of output generating efficiencies that lower its average costs (AC) of production
- Economies of scale help large firms to lower their costs of production beyond what small firms are able to achieve
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Diseconomies of scale occur when an increase in the scale of output results in a higher cost per unit
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As a firm continues increasing its scale of output, it will reach a point where its average costs (AC) will start to increase
- The reasons for the increase in the average costs are called diseconomies of scale
* Economies of scale occur when average costs decrease with increasing output and diseconomies of scale occur when average costs increase with increasing output*
Diagram analysis
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With relatively low levels of output, the firm's average costs are high
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As the firm increases its output, it begins to benefit from economies of scale which lower the average cost per unit
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At some level of output, a firm will not be able to reduce costs any further
- This point is called productive efficiency
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Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale
Causes of internal economies of scale
Spec point — "drawing and interpretation of average total cost (ATC) diagrams to illustrate economies and diseconomies of scale "
Causes of internal economies of scale
- Internal economies of scale occur as a result of the growth in the scale of production within the firm
| Type of economy | Explanation |
|---|---|
| Financial economies | - Large firms can borrow money at lower interest rates, as they are seen as less risky by lenders - They also have access to a wider range of finance sources |
| Managerial economies | - As firms grow, they can hire specialist managers for different departments, leading to more efficient decision-making and improved productivity |
| Marketing economies | - Larger firms can spread the cost of marketing (e.g. advertising, promotion) over a greater output, reducing the cost per unit sold |
| Purchasing economies | - Bigger firms buy inputs (e.g. raw materials) in bulk, allowing them to negotiate lower prices and better terms with suppliers |
| Technical economies | - Large-scale production allows firms to invest in more advanced equipment or use production techniques that smaller firms cannot afford, improving efficiency |
| Risk-bearing economies | - Large firms can spread risk by operating in different markets or producing a range of products, so failure in one area has less impact overall |
Causes of diseconomies of scale
Spec point — Causes of diseconomies of scale
- As a firm continues to increase its scale of output in the long-run, at some point its average costs will start to increase
- The reasons for the increase are called diseconomies of scale
Causes of diseconomies of scale
| Type of diseconomy | Explanation |
|---|---|
| Management diseconomies | - Occur when managers work more in their own interest than in the interest of the firm, e.g. managers become territorial and obstructive thus reducing efficiency and increasing the average costs |
| Communication diseconomies | - Occur when a firm with multiple layers of management and perhaps in multiple geographic locations struggles to communicate quickly and efficiently, leading to slow responses and increased average costs |
| Geographical diseconomies | - Occur when a firm has widespread bases of operations and this leads to logistical and communication challenges which can raise the average costs |
| Cultural diseconomies | - Occur when a firm expands into foreign markets in which workers have very different cultural work or productivity norms, which can raise the average costs |
Causes of external economies of scale
Spec point — Causes of external economies of scale
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External economies of scale occur when there is an increase in the size of the industry in which the firm operates
- The firm is able to benefit from lower average total costs generated by factors outside of the firm
Sources of external economies of scale
| Type of external economy | Explanation |
|---|---|
| Geographic cluster | - As an industry grows, ancillary firms move closer to major manufacturers to cut costs and generate more business - This lowers the average total cost - For example, car manufacturers in Sunderland rely on the service of over 2,500 ancillary firms |
| Transport links | - Improved transport links develop around growing industries in order to help get people to work and to improve the transport logistics - This lowers the average total costs - For example,****Bangalore is know as India's Silicon Valley and transportation projects have been successful in transforming the movement of people and goods |
| Skilled labour | - An increase in skilled labour can lower the cost of skilled labour, thereby lowering the average total cost - The larger the geographic cluster, the larger the pool of skilled labour |
| Favourable legislation **** | - Governments may pass laws that help to lower business costs - This often generates significant reductions in average total costs, as governments support certain industries in order to achieve their wider objectives |
Case Study Discovery Channel in Mediapolis, Singapore
Discovery Channel, a major global broadcaster, has established regional production and broadcasting facilities within Mediapolis, Singapore’s purpose-built media and tech hub. This location provides an excellent example of how external economies of scale benefit large firms as the industry around them expands.
Geographic cluster
- As Mediapolis has grown, ancillary firms offering services like animation, sound design, post-production, and media technology support have moved close to large media clients like Discovery
- This concentration of supporting firms lowers Discovery’s average costs by reducing travel time, enabling faster collaboration, and giving access to multiple suppliers in one location
Transport links
- The development of high-quality transport infrastructure in and around Mediapolis helps Discovery staff and equipment move efficiently across the city and region
- With easy access to metro stations, shuttle buses, and expressways, this reduces logistical costs and improves the reliability of production schedules
Skilled labour
- Singapore’s government has partnered with universities and polytechnics to ensure a constant supply of skilled media professionals, including editors, producers, and broadcast engineers
- Discovery Channel benefits directly from this pool of talent, lowering its recruitment costs and ensuring access to workers with industry-specific expertise
Favourable legislation
- Singapore government pro-media policies, including grants, tax relief, and co-investment schemes, have made it more cost-effective for companies like Discovery to operate in the region
- This government support helps reduce overheads and encourages long-term investment in innovation and digital production
Summary
Discovery Channel’s presence in Singapore’s Mediapolis illustrates how firms can benefit from external economies of scale driven by growth in the wider media industry
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