Economies of

Scale

Igcse business
 Define economies of scale

Learning Differentiate between internal and

external economies of scale
objectives
Explain the different types of
internal economies of scale.
Cost &
Revenue
Economies of scale occur when the average costs of
running a business fall as a firm increases its output and
size.

Minimum efficient scale (MES) AC

Economies of scale Diseconomies of scale

Output
Example
If I buy ingredients to bake 1
cake it will cost £4.
If I bake a second or third cake I
will be able to use ingredients
already bought so the average
cost of the cake decreases.
 Average Cost
Average Cost = Total Cost
Number of Units Produced
Complete the table below:

Output Total cost Average cost

5 1000
7 1500 250
2000 200
12 2160
15 150
2200 110
 INTERNAL AND EXTERNAL ECONOMIES OF SCALE

• Internal Economies of Scale: These arise from within the

firm itself as it expands its own operations in the long run.
They result from the firm's own actions and decisions.
• External Economies of Scale: These arise from factors
outside the firm, often related to the industry or the
business environment in which the firm operates. They are
shared by multiple firms within an industry or geographic
region.

ECONOMIES OF SCALE
 DO IT NOW!!! (5 mins)

In your notebook, draw an accurately labelled graph

showing areas of economies and diseconomies of
Scale
 DIFFERENT TYPES OF INTERNAL ECONOMY OF SCALE

• Technical economies of scale

• Managerial economies of scale
• Purchasing economies of scale
• Financial economies of scale
• Risk-bearing economies of scale
• Marketing economies of scale

ECONOMIES OF SCALE
 TECHNICAL ECONOMIES OF SCALE

• Specialised Equipment: For example, a

manufacturer of computer chips may be
able to invest in cutting-edge
semiconductor equipment that allows
them to produce a larger quantity of chips
with high precision, resulting in lower
costs per chip.
• Automated Production: Automation Specialised Automated
reduces the need for manual labour, capital manufacturing
minimizing errors, and increasing the
speed of production.

ECONOMIES OF SCALE
 MANAGERIAL ECONOMIES OF SCALE

• This is a form of division of labour where firms employ

specialists to supervise production systems
• Better management and increased investment in human
resources and the use of specialist equipment, such as
networked computers can improve communication, raise
productivity, and thereby reduce unit costs.

ECONOMIES OF SCALE
 FINANCIAL ECONOMIES OF SCALE

• Financial markets usually rate larger, more established firms to be

more credit worthy and have access to loans with favourable rates
of borrowing – they may borrow much more overall than a small
firm and pay a lower rate of interest (although the bank still
benefits because of the large amount borrowed)
• Smaller firms often pay higher interest rate on overdrafts and loans.
Whereas businesses listed on the stock market can normally raise
new financial capital more cheaply through the sale of equities to
the capital market.

ECONOMIES OF SCALE
 PURCHASING ECONOMIES OF SCALE

• A large firm can purchase factor inputs

in bulk at lower prices if it has
monopsony power – we can call these
Bulk purchases
purchasing economies.
• Large food retailers have monopsony
power when purchasing their supplies
from farmers and wine growers and in
completing supply contracts from food
processing businesses. Negotiations
with suppliers

ECONOMIES OF SCALE
 RISK-BEARING ECONOMIES OF SCALE

• Risk-bearing economies of scale can occur when larger businesses are

better equipped to manage certain types of risks more efficiently than
smaller ones.
• This advantage arises from their size, and from product and market
diversification to make their business more resilient.
• Example: Insurance companies diversify their risk exposure across a
wide range of policies and customers
• Example: Amazon has since diversified into e-commerce, cloud
computing (Amazon Web Services), digital streaming (Amazon Prime
Video), and much more!

ECONOMIES OF SCALE
Internal Economies of scale
Activity
S/N Types of internal Explanation
economies of scale

1
Using the table below briefly 2
explain the 6 types of internal
3
economies. Use what you have
learnt from today or previous 4
lessons and your textbook. 5

6
Activity S/N Types of external
economies of scale
Explanation

Using the table, briefly explain the 1

4 types of external economies of 2
scale. Use your textbook as a
3
guide.
4
 1. Purchasing Economies 2. Managerial Economies

6. Marketing Economies 3. Financial Economies

5. Risk-bearing Economies 4. Technical Economies

Occurs when a business
invests in new technology
and is able to increase Occurs when a business
production. As a result, produces a range of products,
production costs per unit which means it is not
will fall. dependant on just one
product.

Occurs when a large firm can

employ specialist workers to Occurs when a
complete tasks and can spread business buys goods in
the cost bulk and benefits
from discount.

Occurs when a large

business can borrow
money at a lower rate of Occurs when a business
interest than a smaller grows and the average cost
business of advertising per unit falls
 1. Purchasing Economies 2. Managerial Economies

Occurs when a business Occurs when a large firm

buys goods in bulk and can employ specialist
benefits from discount. workers to complete tasks
and can spread the cost

6. Marketing Economies 3. Financial Economies

Occurs when a large

Occurs when a business
business can borrow money
grows and the average cost
at a lower rate of interest
of advertising per unit falls
than a smaller business

5. Risk-bearing Economies 4. Technical Economies

Occurs when a business Occurs when a business

produces a range of invests in new technology
products, which means it is and is able to increase
not dependant on just one production. As a result,
product. production costs per unit
will fall.
 I E
n x
t t
e e
r r
•Technical n n •Location
•Purchasing a a •Skilled Labour
•Financial l l •Transport
•Managerial E E •Reputation of
•Risk bearing c c Area

•Marketing o o
n n
o o
m m
i i
e e
s s
 WHAT ARE EXTERNAL ECONOMIES OF SCALE?

• External economies of scale occur when the cost

advantages of producing a good or service extend beyond
an individual firm and benefit multiple firms within a
specific industry or geographical area.
• External economies of scale provide cost advantages to all
firms within an industry or sector, not just to a single firm.
• Often, external economies of scale are observed in clusters
where businesses in the same industry are in proximity

ECONOMIES OF SCALE
 EXAMPLES OF EXTERNAL ECONOMIES OF SCALE

Media City Cambridge (UK)

(Salford) Science Park
ECONOMIES OF SCALE
 REASONS FOR EXTERNAL ECONOMIES OF SCALE

• Infrastructure Economies: If an industry cluster develops in a specific

geographic area, firms can benefit from shared infrastructure, such as
transportation networks, utilities, and specialized services.
• Knowledge and Labour Pool: In certain regions, there might be a
concentration of skilled workers and a strong knowledge-sharing environment.
Firms in these regions can tap into a well-trained labour force and easily access
industry-specific knowledge. Business can benefit from the research activities
of local / regional universities.
• Supplier Networks: Clusters of related businesses can lead to a strong supplier
network. The automotive industry often sees this, as car manufacturers benefit
from well-established networks of suppliers providing specialized components.

ECONOMIES OF SCALE
 EXAMPLES OF EXTERNAL ECONOMIES OF SCALE

• Silicon Valley, California - a region in the San Francisco Bay Area

known for its concentration of high-tech companies, startups,
research institutions, and venture capital firms. The proximity of
these entities fosters collaboration, knowledge sharing, and access
to a highly skilled workforce.
• Bangalore, India – Bangalore has become a global IT hub. The city's
concentration of IT companies, educational institutions, and
technology parks has fostered an environment of collaboration and
innovation.

ECONOMIES OF SCALE
 UK EXAMPLES OF EXTERNAL ECONOMIES OF SCALE

• Cambridge - Technology and Biotech: The city of Cambridge, particularly

the area known as the "Cambridge Cluster" or "Silicon Fen," is a hub for
technology, biotech, and pharmaceutical companies.
• Manchester - Creative and Media Industries: Manchester has a vibrant
creative and media industry, with a focus on television, film, music, and
digital media.
• Sheffield - Advanced Manufacturing: Sheffield has a tradition in advanced
manufacturing in industries such as aerospace, steel, and engineering
• Dundee has developed a notable presence in the video game sector with a
cluster of highly successful computer games companies based there.

ECONOMIES OF SCALE
Diseconomies of Scale
The opposite of an economy of scale is a diseconomy of scale.

Diseconomies of scale occurs when

Average Costs start to rise with increased
output.
 WHAT ARE DISECONOMIES OF SCALE?

• Diseconomies of scale are increases in the unit (average) cost of supply in the
long run due to decreasing returns to scale.
• Diseconomies of scale mean that a business has moved beyond their optimum
size in the long run. Businesses are suffering from productive inefficiency
perhaps because of organisational slack.
• Breakdowns in communication may lead to the departure of highly skilled
workers from a business – this a loss of human capital for the business
• Businesses then might have to raise their prices to cover increased unit costs.
• Lost cost competitiveness could lead to declining market share and a fall in the
share price if the business is on the stock market.

ECONOMIES OF SCALE
 REASONS FOR DISECONOMIES OF SCALE

Higher Regulatory Costs Office Politics / Industrial Risk aversion among

for bigger businesses Relations salaried staff

Waste / Inefficiency in
large organisations

ECONOMIES OF SCALE
 REASONS FOR DISECONOMIES OF SCALE

• Complexity and Coordination: As an organization grows, it may

become more complex, with more (costly) layers of management.
• Bureaucracy: Larger organizations often develop bureaucratic
structures to manage the increased complexity. Innovation may
slow down as employees / managers become risk-averse.
• Cultural and Organisational Issues: As organisations grow,
maintaining a cohesive culture and shared values can become more
challenging. This can impact employee morale, motivation, and
have a damaging effect on labour productivity.

ECONOMIES OF SCALE
How do firms grow?
3 main ways

Merging – two or more firms join together to

become one.

Take over – when a firm buys control of

another

Internal expansion – increasing production

from inside business
 Backwards
Vertical
Integration
Wheat Farmer

Horizontal Flour Diversification

Integration Miller Purchases a
Flour Miller B Perfume
A manufacturer

Forwards
Vertical
Integration
Bakery
 GIVE ME 3…
Examples of internal economies of
scale at a business such as Pure Gym

ECONOMIES OF SCALE
 GIVE ME 3…
Internal economies of scale at Pure Gym

1
Purchasing power: Can use their monopsony power to negotiate lower
prices from suppliers for things such as gym equipment, fitness gear, food
and cleaning supplies.

2
Spreading fixed costs over many customers: Pure Gym must pay rent,
utilities, and insurance regardless of how many members it has. As Pure
Gym grows, this lowers the average cost per member.

3 Financial economies: Pure Gym can negotiate lower rates with commercial
landlords, and (in theory) it can borrow money at lower interest rates.

ECONOMIES OF SCALE
 GIVE ME 3…
Examples of economies of scale
that larger hotel chains in the
UK can benefit from.

INTERNAL SCALE
 GIVE ME 3…
Examples of economies of scale that large hotel chains in the UK can benefit from

Bulk Purchasing - Larger hotel chains purchase supplies in bulk, such as linens,
1 toiletries, and food items. Their monopsony power means they can negotiate lower
prices and achieve cost savings not be possible for smaller “boutique” hotels.

Technology - Large hotel chains invest in centralized reservation systems, property

2 management systems, and other IT infrastructure. By standardizing their technology
across multiple locations, they can reduce costs and improve productive efficiency.
Marketing and Branding - Large hotel chains can leverage their brand recognition and
3 marketing budgets across multiple locations to drive demand and increase occupancy
rates. Marketing is a fixed cost – consider Premier Inn’s TV advertising campaigns.

INTERNAL SCALE
Homework