Questions and Answers
What are economies of scale?
Benefits and drawbacks in increasing the size of operation of a business, with cost advantages known as economies of scale and cost disadvantages known as diseconomies of scale.
What is one way large firms experience economies of scale?
How do large firms lower their unit costs compared to small firms?
By spreading fixed costs more thinly over higher sales volumes.
What is competitive advantage in the context of economies of scale?
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Total cost rises while average cost falls as a firm grows in size.
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In what ways do small firms compete?
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What can cause a business to experience diseconomies of scale?
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Study Notes
Economies of Scale
- Economies of scale refer to cost advantages gained through business expansion, leading to lower unit costs.
- Diseconomies of scale represent the disadvantages of growing larger, resulting in increased unit costs.
Benefits of Economies of Scale
- Purchasing Economies: Larger firms often obtain discounts by buying in bulk, reducing the per-unit cost.
- Marketing Economies: Fixed promotional costs are spread over higher output, lowering the marketing cost per unit.
- Administrative Economies: Fixed management and IT costs are diluted over a larger scale of operations, enhancing efficiency.
- Research and Development Economies: Fixed costs of product development are distributed over more units, facilitating innovation.
Fixed Costs and Unit Cost
- Large firms enjoy lower unit costs because fixed costs are spread out across many sales.
- Example: A £1 million advertising campaign results in a per-unit cost of £500,000 if two items are sold, but drops to £1 if one million items are sold.
Competitive Advantage
- Due to economies of scale, large organizations can produce goods at a lower cost than smaller competitors, giving them a competitive edge.
Total Cost vs. Average Cost
- Total costs rise as firms expand due to increased resource use, but average cost per unit can decrease, benefiting larger operations.
Small Firms and Competition
- Small businesses typically compete in service sectors with limited economies of scale or by offering premium, niche products at higher prices, appealing to customers’ willingness to pay for exclusivity.
Diseconomies of Scale
- Overexpansion can lead to diseconomies of scale, where unit costs rise due to:
- Ineffective Communication: Difficulties in coordinating large workforces can lead to delays and misunderstandings.
- Reduced Motivation: Employees may feel disengaged in large firms, leading to decreased productivity and higher costs.
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Description
Test your knowledge of economies of scale with these flashcards. Understand both the benefits and drawbacks of increasing business operations and learn key concepts such as purchasing economies. This quiz is perfect for students of economics and business management.
