Economies and diseconomies of scale Cambridge IGCSE Business Studies revision
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In plain words
A firm that makes a million bars of soap can make each one more cheaply than a firm that makes a thousand. As output grows, the cost of each unit falls. These savings are economies of scale.
They do not go on for ever. A firm can become too big to run well, and then the cost of each unit starts to rise again.
5 things to know
- Economies of scale are falls in average cost as the scale of production increases.
- Internal economies come from the firm itself growing: purchasing (discounts for buying in bulk), technical (bigger, more efficient machines), financial (cheaper loans), managerial (specialist managers), marketing (advertising costs spread over more sales) and risk-bearing (many products or markets).
- External economies come from the whole industry growing in one area: a pool of skilled workers, better infrastructure, and specialist suppliers nearby.
- Diseconomies of scale are rises in average cost when a firm grows too large: poor communication, slow decisions and bureaucracy, difficulty in controlling the business, and workers who feel remote from the top and lose motivation.
- The average cost curve is U-shaped: it falls with economies of scale, reaches a lowest point where the firm is most efficient, then rises with diseconomies.
Worked example
A firm makes 1000 units for a total cost of $20 000. When it makes 5000 units the total cost is $60 000. What has happened to average cost?
- Average cost at 1000 units = 20 000 ÷ 1000 = $20.
- Average cost at 5000 units = 60 000 ÷ 5000 = $12.
- Average cost has fallen from $20 to $12: the firm has gained economies of scale.
Tips and tricks
- Economies of scale are about average cost, the cost of each unit. Total cost still rises as output rises.
- Internal: this firm grows. External: the industry grows. Use that test when a question asks you to classify one.
It lands in your notebook with its questions as flashcards.
Economies and diseconomies of scale: 5 questions and answers
These are the quiz’s questions. Do the quiz first, then come back here for the ones that got you.
A firm receives a discount for buying raw materials in large quantities. This is
Bulk buying lowers the cost of each unit bought.
Which is an external economy of scale?
It comes from the growth of the industry in the area, not from one firm.
What happens to average cost when a firm has diseconomies of scale?
The firm has grown beyond its most efficient size.
Total cost is $8000 at an output of 400 units. What is the average cost?
8000 ÷ 400 = $20.
Which is a cause of diseconomies of scale?
Less motivated workers produce less, so each unit costs more.
Quiz
5 questions
Tap an answer and you’ll see straight away whether it’s right, and why.
Worksheet
3 questions, 8 marks. Write your answers on paper, then check them.
Economies and diseconomies of scale
Cambridge IGCSE Business Studies 0450 · 8 marks · papermunch.org
Name ______________________________ Date ______________
Define economies of scale.[2]
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The fall in average cost of production that comes from an increase in the scale of output.
Explain two internal economies of scale a large supermarket chain may gain.[3]
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Purchasing: it buys in bulk and gets discounts from suppliers. Financial: banks see it as low risk and lend to it at lower interest rates.
Explain one cause of diseconomies of scale.[3]
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In a very large firm, messages pass through many layers of management, so communication is slow and mistakes are made, which raises average cost.
Answers: Economies and diseconomies of scale
- 1. The fall in average cost of production that comes from an increase in the scale of output.
- 2. Purchasing: it buys in bulk and gets discounts from suppliers. Financial: banks see it as low risk and lend to it at lower interest rates.
- 3. In a very large firm, messages pass through many layers of management, so communication is slow and mistakes are made, which raises average cost.