Question

Do we ever really reach the long-term to ensure that we are reaching economies of scale? Why or why not?

Answer 1

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.

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.

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.

DEFINATION :

Economies of Scale refer to the cost advantage experienced by a firm when it increases its level of output. The advantage arises due to the inverse relationship between per-unit fixed cost and the quantity produced. The greater the quantity of output produced, the lower the per-unit fixed cost. Economies of scale also result in a fall in average variable costs (average non-fixed costs) with an increase in output. This is brought about by operational efficiencies and synergies as a result of an increase in the scale of production.

Economies of scale can be implemented by a firm at any stage of the production process. In this case, production refers to the economic concept of production and involves all activities related to the commodity, not involving the final buyer. Thus, a business can decide to implement economies of scale in its marketing division by hiring a large number of marketing professionals. A business can also adopt the same in its input sourcing division by moving from human labor to machine labor.

Types of Economies of Scale :

1. Internal Economies of Scale:

This refers to economies that are unique to a firm. For instance, a firm may hold a patent over a mass production machine, which allows it to lower its average cost of production more than other firms in the industry.

2. External Economies of Scale :

These refer to economies of scale enjoyed by an entire industry. For instance, suppose the government wants to increase steel production. In order to do so, the government announces that all steel producers who employ more than 10,000 workers will be given a 20% tax break. Thus, firms employing less than 10,000 workers can potentially lower their average cost of production by employing more workers. This is an example of an external economy of scale – one that affects an entire industry or sector of the economy.

Sources of Economies of Scale:

1. Purchasing
Firms might be able to lower average costs by buying the inputs required for the production process in bulk or from special wholesalers.

2. Managerial
Firms might be able to lower average costs by improving the management structure within the firm. The firm might hire better skilled or more experienced managers.

3. Technological
A technological advancement might drastically change the production process. For instance, fracking completely changed the oil industry a few years ago. However, only large oil firms that could afford to invest in expensive fracking equipment could take advantage of the new technology.

Example of economies of scale :
Examples of economies of scale include. To produce tap water, water companies had to invest in a huge network of water pipes stretching throughout the country. The fixed cost of this investment is very high. However, since they distribute water to over 25 million households, it brings the average cost down.

Key takeways

• Economies of scale are cost advantages companies experience when production becomes efficient, as costs can be spread over a larger amount of goods.
• A business's size is related to whether it can achieve an economy of scale—larger companies will have more cost savings and higher production levels.
• Economies of scale can be both internal and external. Internal economies are caused by factors within a single company while external factors affect the entire industry.

Limits to Economies of Scale:  Management technique and technology have been focusing on limits to economies of scale for decades.

• Set-up costs are lower due to more flexible technology. Equipment is priced more closely to match production capacity, enabling smaller producers such as steel mini-mills and craft brewers to compete more easily.
• Outsourcing functional services make costs more similar across businesses of various sizes. These functional services include accounting, human resources, marketing, treasury, legal, and information technology.
• Micro-manufacturing, hyper-local manufacturing, and additive manufacturing (3D printing) can lower both set-up and production costs. Global trade and logistics have contributed to lower costs, regardless of the size of an individual plant.
• In aggregate, the average cost of trade-able goods has been falling in industrial countries since about 1995.