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In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation (typically measured by the amount of output produced), with cost per unit of output decreasing with increasing scale. Based on, economies of scale, there may be technical, statistical, organizational, or related factors to the degree of market control.
Economies of scale apply to a variety of organizational and business situations and at various levels, such as production, plant, or an entire enterprise. When average costs start falling as output increases, then economies of scale occur. Some economies of scale, such as capital cost of manufacturing facilities and friction loss of transportation and industrial equipment, have a physical or engineering basis.
Another source of scale economies is the possibility of purchasing inputs at a lower per-unit cost when they are purchased in large quantities.
The economic concept dates back to Adam Smith and the idea of obtaining larger production returns through the use of division of labor. Diseconomies of scale are the opposite.
Economies of scale often have limits, such as passing the optimum design point where costs per additional unit begin to increase. Common limits include exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry. A common limit for a low cost per unit weight commodities is saturating the regional market, thus having to ship product uneconomic distances. Other limits include using energy less efficiently or having a higher defect rate.
Large producers are usually efficient at long runs of a product grade (a commodity) and find it costly to switch grades frequently. They will, therefore, avoid specialty grades even though they have higher margins. Often smaller (usually older) manufacturing facilities remain viable by changing from commodity-grade production to specialty products.
Economies of scale must be distinguished from economies stemming from an increase in the production of a given plant. When a plant is used below its optimal production capacity, increases in its degree of utilization bring about decreases in the total average cost of production. As noticed, among the others, by Nicholas Georgescu-Roegen (1966) and Nicholas Kaldor (1972) these economies are not economies of scale.
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➯Economies of scale are cost advantages reaped by companies when production becomes efficient. Companies can achieve economies of scale by increasing production and lowering costs. This happens because costs are spread over a larger number of goods. Costs can be both fixed and variable.
➯The size of the business generally matters when it comes to economies of scale. The larger the business, the more the cost savings.
➯Economies of scale can be both internal and external. Internal economies of scale are based on management decisions, while external ones have to do with outside factors.Understanding Economies of Scale
➯Economies of scale are an important concept for any business in any industry and represent the cost-savings and competitive advantages larger businesses have over smaller ones.
➯Most consumers don't understand why a smaller business charges more for a similar product sold by a larger company. That's because the cost per unit depends on how much the company produces. Larger companies are able to produce more by spreading the cost of production over a larger amount of goods.
➯An industry may also be able to dictate the cost of a product if there are a number of different companies producing similar goods within that industry.
➯There are several reasons why economies of scale give rise to lower per-unit costs. First, specialization of labor and more integrated technology boost production volumes. Second, lower per-unit costs can come from bulk orders from suppliers, larger advertising buys, or lower cost of capital. Third, spreading internal function costs across more units produced and sold helps to reduce costs.
➯Internal functions include accounting, information technology, and marketing. The first two reasons are also considered operational efficiencies and synergies. The second two reasons are cited as benefits of mergers and acquisitions.