1.6 GROWTH AND EVOLUTION
NOTES
Economies and Diseconomies of scale (AO2):
One major reason why businesses aim to grow is to benefit from economies of scale
Economies of scale:
Definition = a proportionate saving in costs gained by an increased level of production, productive
efficiency and reductions in a firm's unit (average) costs of production that result in an increase in the
scale of operations with cost per unit of output generally decreasing with increasing scale as fixed
costs are spread out over more units of output.
Economies of scale can help businesses to gain a competitive cost advantage because lower average
costs can mean a combination of lower prices being charges to customers and a higher profit margin
earned on each unit sold.
The average cost (AC):
- is the cost per unit of output?
- It is calculated by dividing total costs (TC) by the quantity of output (AC = TC ÷ Q)
- for example, if total costs of producing 100 shirts amounts to $8000 then the cost of each
shirt is $8
- average costs consist of two components: average fixed costs (AFC) and average variable
costs (AVC)
- AFC is calculated by dividing the total fixed costs by the level of output (AFC = TFC ÷ Q)
- AVC is calculated by dividing total variable costs by the level of output (AVC = TVC ÷ Q)
- The average fixed costs of a firm will decline continuously with larger levels of output,
because the TFC remains constant but are spread over an increasing amount of output.
Internal Economies of Scale:
Economies of scale that occur inside the firm and are within its control are known as internal
economies of scale.
By operating on a larger scale, a business can reduce its average costs of production due to any
combination of the factors below.
The relative importance of each depends on the actual firm under consideration:
Technical economies = The best technology that will advantage a business
Financial economies = Borrowing and funding potential
Managerial economies = Expertise that will drive down costs for a business
Specialisation economies = similar to managerial economies of scale but result from division
of labour of the workforce rather than the management.
, Marketing economies = More effective marketing through economy of scope
Purchasing economies = Whole sale buying power (monopsony - only buyer of a good and
can negotiate better prices if there are many sellers)
Risk bearing economies = can handle the volatility in one industry or region because they
have other business segments generating profits.
External Economies of Scale:
Economies of scale that occur within the industry and are largely beyond an individual firms control
are known as external economies of scale.
External economies of scale = are costs saving benefits of large scale operations arising from outside
the business due to its favourable location or general growth in the industry
Examples of external economies include:
Technological progress = increase the productivity within the industry (the internet has
created he costs saving for business engages in e – commerce)/ Cost savings because of the
internet
Improves transportation networks = help to ensure prompt deliveries (employees who are
late to work due to poor transportation links cost the business money)/ Public transit,
workers arriving on time, easy access for customers
Abundance of skilled labour = exist in the local area, perhaps through government aided
training programmes or reputable education and training facilities in a certain location/
specialty know-how in the region, specialty schools (computers, auto, fisheries), efficiency in
recruiting workers.
Regional specialisation = that a particular location or country has a highly regarded and
trustworthy reputation for producing a certain good or service.
Diseconomies of Scale:
Business can become too large. There comes a tipping point when economies of scale can no longer
be exploited.
Definition = the results of higher unit costs as a firm continues to increase in size (the business
becomes outsized and inefficient so average costs begin to rise)
Internal Diseconomies of Scale:
Internal diseconomies usually occur due to managerial problems.
The potential for large firms to experience diseconomies of scale means that some businesses prefer
to grow via franchising.
Example include:
Lack control and coordination as the organization grows
NOTES
Economies and Diseconomies of scale (AO2):
One major reason why businesses aim to grow is to benefit from economies of scale
Economies of scale:
Definition = a proportionate saving in costs gained by an increased level of production, productive
efficiency and reductions in a firm's unit (average) costs of production that result in an increase in the
scale of operations with cost per unit of output generally decreasing with increasing scale as fixed
costs are spread out over more units of output.
Economies of scale can help businesses to gain a competitive cost advantage because lower average
costs can mean a combination of lower prices being charges to customers and a higher profit margin
earned on each unit sold.
The average cost (AC):
- is the cost per unit of output?
- It is calculated by dividing total costs (TC) by the quantity of output (AC = TC ÷ Q)
- for example, if total costs of producing 100 shirts amounts to $8000 then the cost of each
shirt is $8
- average costs consist of two components: average fixed costs (AFC) and average variable
costs (AVC)
- AFC is calculated by dividing the total fixed costs by the level of output (AFC = TFC ÷ Q)
- AVC is calculated by dividing total variable costs by the level of output (AVC = TVC ÷ Q)
- The average fixed costs of a firm will decline continuously with larger levels of output,
because the TFC remains constant but are spread over an increasing amount of output.
Internal Economies of Scale:
Economies of scale that occur inside the firm and are within its control are known as internal
economies of scale.
By operating on a larger scale, a business can reduce its average costs of production due to any
combination of the factors below.
The relative importance of each depends on the actual firm under consideration:
Technical economies = The best technology that will advantage a business
Financial economies = Borrowing and funding potential
Managerial economies = Expertise that will drive down costs for a business
Specialisation economies = similar to managerial economies of scale but result from division
of labour of the workforce rather than the management.
, Marketing economies = More effective marketing through economy of scope
Purchasing economies = Whole sale buying power (monopsony - only buyer of a good and
can negotiate better prices if there are many sellers)
Risk bearing economies = can handle the volatility in one industry or region because they
have other business segments generating profits.
External Economies of Scale:
Economies of scale that occur within the industry and are largely beyond an individual firms control
are known as external economies of scale.
External economies of scale = are costs saving benefits of large scale operations arising from outside
the business due to its favourable location or general growth in the industry
Examples of external economies include:
Technological progress = increase the productivity within the industry (the internet has
created he costs saving for business engages in e – commerce)/ Cost savings because of the
internet
Improves transportation networks = help to ensure prompt deliveries (employees who are
late to work due to poor transportation links cost the business money)/ Public transit,
workers arriving on time, easy access for customers
Abundance of skilled labour = exist in the local area, perhaps through government aided
training programmes or reputable education and training facilities in a certain location/
specialty know-how in the region, specialty schools (computers, auto, fisheries), efficiency in
recruiting workers.
Regional specialisation = that a particular location or country has a highly regarded and
trustworthy reputation for producing a certain good or service.
Diseconomies of Scale:
Business can become too large. There comes a tipping point when economies of scale can no longer
be exploited.
Definition = the results of higher unit costs as a firm continues to increase in size (the business
becomes outsized and inefficient so average costs begin to rise)
Internal Diseconomies of Scale:
Internal diseconomies usually occur due to managerial problems.
The potential for large firms to experience diseconomies of scale means that some businesses prefer
to grow via franchising.
Example include:
Lack control and coordination as the organization grows
