In microeconomics, economies of scale are understood to be the cost-benefits that firms derive from the scale of their operations (usually measured by the amount of output generated), with the cost per unit of output decreasing as scale increases. Depending on economies of scale, there may be technical, statistical, organizational or related factors for the degree of market control. When average costs begin to decline with growth in output, economies of scale emerge.
Economies of scale apply to different organizational, business and level situations. Like the production, the plant or the company as a whole. Some economies of scale, such as capital costs for production equipment and wear and tear losses in transportation and industrial equipment, have a physical or technical basis. The ability to purchase inputs at a lower unit cost if purchased in large quantities is also considered economies of scale.
Economy of scale definition
Achieving higher levels of production while reducing operating costs is an objective that is constantly sought for companies. And this is what is meant by economy of scale. Maximize the production levels of a product, lowering the unit cost for the production of said product. Said in the simplest way possible: the economy of scale is producing more at a lower cost per unit produced.
This is a very attractive production model for companies, as it allows them to improve their performance. As well as being able to offer their products with more competitive prices. The more they are produced, the lower the unit costs. This allows the company to lower its selling prices to the consumer and obtain greater economic benefits even when it sells cheaper. This economic model is much more common in large companies that have a large installed production capacity.
What are the types of economies of scale?
Before talking about the different types of economies of scale, we must make a parenthesis to clarify that, although many people consider that economies of scale and economies of scope are the same, this is a mistake. They are different. While the first seeks strategies to reduce costs through production increases of one product, the second seeks to diversify its production line with two or more products to maintain or reduce its operating costs.
Now that you know what economy of scale is, we can say that it is divided into two types. The internal economy of scale will depend directly on all the actions that the management of the company undertakes internally, in order to reduce the production costs of a specific product. And according to its result we can classify it in constant, positive or negative economy of scale. The other type is the external economy of scale, which occurs through no fault of the company.
When do economies of scale appear?
The first notions of economies of scale can be found in the work of the Scottish British economist and philosopher Adam Smith (1723 – 1790). Known as the father of modern economics, Smith’s theory is based on the optimization of production. That is, the more units are produced and the faster it becomes, the lower the unit cost per unit of production. And, therefore, the greater the benefit obtained. The higher the productivity levels, the lower the costs.
However, it was not until the beginning of the 20th century that this theory of production began to be used on a larger scale to reduce costs. And it was applied in the assembly lines used in the manufacture of the famous Henry Ford Model T. In this model implemented in their factories, each worker was assigned a specific task no matter how small. With this, he achieved higher levels of efficiency and performance with the specialization of labor.
When does the economy of scale occur?
We can say, without a doubt, that the economy of scale occurs when the company manages to increase its production levels by reducing production costs for each unit of product produced. This means that, as the company grows and the production units increase, it will have more possibilities to reduce its costs. The bigger the business, the more costs will be saved. In this way, the economy of scale enables the economic growth of companies.
For purposes of economies of scale, the size of the company as a whole is important. This is because the larger the company and its production, the costs will be distributed among a greater number of goods. However, costs can be both fixed and variable. The fixed ones, as the name implies, remain unchanged regardless of the increase in production. While the variables are influenced by these increases.
What are the differences with diseconomies of scale?
We know what economy of scale is, but what are diseconomies of scale? These occur when companies have exhausted all their production potential beyond their own capacities. Generating a decrease in performance levels and, therefore, an increase in production costs per unit produced. That is, it is the complete opposite of the economy of scale. In the diseconomy of scale the cost of production per unit increases with the same increase in production.
As we can see the difference between these two production models is obvious. The economy of scale seeks the way to reduce production costs through the increase of production itself. While the diseconomy of scale increases these costs as the company seeks to produce more. What generates that many companies make the decision not to expand their production for fear of increasing their costs, and the possible reduction of their economic benefits.