Question

What are the three types of scale? Why does each type of scale occur? Explain. (minimum 200 words)

Answer 1

what are the 3 types of scale and why does each type of scale occur??

Meaning

When more units of a good or a service can be produced on a larger scale, yet with (on average) less input costs, economies of scale (ES) are said to be achieved. Alternatively, this means that as a company grows and production units increase, a company will have a better chance to decrease its costs. According to theory, economic growth may be achieved when economies of scale are realized.

3 types of economies of scale:

Internal and External Economies of Scale
Alfred Marshall made a distinction between internal and external economies of scale. When a company reduces costs and increases production, internal economies of scale have been achieved.

External economies of scale occur outside of a firm, within an industry. Thus, when an industry's scope of operations expands due to, for example, the creation of a better transportation network, resulting in a subsequent decrease in cost for a company working within that industry, external economies of scale are said to have been achieved. With external ES, all firms within the industry will benefit.

Just like there are economies of scale, diseconomies of scale (DS) also exist. This occurs when production is less than in proportion to inputs. What this means is that there are inefficiencies within the firm or industry resulting in rising average costs

Economies of Scale occur for various reasons.

1. Specialization and division of labour:
In large scale operations workers can do more specific tasks. With little training they can become very proficient in their task, this enables greater efficiency. A good example is an assembly line with many different jobs.

2. Technical.
Some production processes require high fixed costs e.g. building a large factory. If a car factory was then only used on a small scale it would be very inefficient to run. By using the factory to full capacity average costs will be lower.

3. Bulk buying:
If you buy a large quantity then the average costs will be lower. This is because of lower transport costs and less packaging. This is why supermarkets get lower prices from suppliers than local corner shops.

4. Spreading overheads.
If a firm merged it could rationalise its operational centres. E.g. it could have one head office rather than two.

5. Risk Bearing economies.
Some investments are very expensive and perhaps risky, therefore only a large firm will be able and willing to undertake the necessary investment. E.g. pharmaceutical industry needs to take risks in developing new drugs

6. Marketing Economies of scale.
There is little point a small firm advertising on a national TV campaign because the return will not cover the high sunk costs

7. The container principle.
To increase capacity 8 fold it is necessary to increase surface area only 4 fold.

8. Financial economies.
A bigger firm can get a better rate of interest than small firms

9. External economies of scale:
This occurs when firms benefit from the whole industry getting bigger. E.g. firms will benefit from better infrastructure, access to specialized labour and good supply networks. E.g. micro chip producers often set up in Silicon valley

Conclusion
The key to understanding ES and DS is that the sources vary. A company needs to determine the net effect of its decisions affecting its efficiency, and not just focus on one particular source. Thus, while a decision to increase its scale of operations may result in decreasing the average cost of inputs (volume discounts), it could also give rise to diseconomies of scale if its subsequently widened distribution network is inefficient because not enough transport trucks were invested in as well. Thus, when making a strategic decision to expand, companies need to balance the effects of different sources of ES and DS so that the average cost of all decisions made is lower, resulting in greater efficiency all around.