Question

In the context of the financial system, economies of scale refers to:

The ability of banks to trade stocks efficiently The ability of the government to make better decisions about capital allocation Costs being negatively related to size Less risk for small institutions A reduction in volatility for liquid securities

Answer 1

In the context of financial system, economies of scale refers to cost being negatively related to size.

Economies of scale refers to the situation when the cost of production of the company decreases as the number of units produced increases. In other words, the cost of production decreases as the size of production increases. In case of banking and financial services, the banks enjoy economies of scale when they provide variety of ways to utilize the same service. For example, banks provide different ways for their customers to carry out cash transactions i.e. online cash transfer, net banking, debit card, credit card etc. There are certain charges that are paid by the customer for availing these services. As the number of customers utilizing such services increases, the bank's cost of providing these services decreases. Thus, it enjoys economies of scale as cost is negatively related to size.