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What are Economies of Scale? And why you should care🗺

What are Economies of Scale? And why you should care🗺

If a firm were to double its inputs( the amount of effort, man power or work) then there are only 3 possible things that could possibly happen.😶

It doubles its output:⚖

This means it has achieved a constant amount of output as the inputs. This means the company is experiencing constant returns to scale. This indicates it has hit its max point for gains made through scaling..
It more than doubles its output: this means it is now achieving more than equal output.This means the company is experiencing increasing returns to scale. This could be due to new production techniques such as mass production due to getting bigger.

It does not more than double but increases:⭐

If the output falls then there is now a negative output. This means the company is experiencing decreasing returns to scale as it has now gotten to big and exceeded to point at which it sees any gains from scaling.✂

But, the big question here is what happens to cost? Well, this is where economies of scale comes in.

Economies of scale is the idea of getting bigger to reduce costs. 💯

This is when the long run average cost per unit falls as you increase production. This happens when you are getting an increasing return in scale as you produce more. This happens because unit costs are made up of fixed costs and variable costs. The variable costs are the costs it takes to make each unit whilst the fixed costs are the costs for things such as rent, staff etc. Fixed costs are divided amongst the total units produced to get the fixed cost per unit. This amount is then added to the variable cost per unit to get the total cost to produce 1 unit. If we produce more and our fixed costs stay the same or rise at slower rate then we have economies of scale.

This happens because productivity increases as you grow due to things such as mass production, new techniques etc. Although the total cost might seem higher, the average cost per unit is much lower.

Economies of scale can also be achieved due to firms having a bigger buying power which allows them to negotiate discounts in their material costs(variable costs).

Did you know that the lord of the rings trilogy were all filmed at the same time😱😱 rather than filming them at different intervals. This meant that all the costs to produce 3 movies were absorbed in the filming of one. Although the cost of filming 3 at once might have been more than filming one this cost will still be much lower than filming three movies at three different intervals when you factor in traveling costs etc.

Economies of scale can not continue forever though, after a while average costs per unit will become constant(constant returns to scale) 🧣as they hit their max point regardless of how much output you produce and in the long run if production continues you will experience diseconomies of scale which is when costs begin to rise after their most efficient point. This is due to output being far further out and higher than the current infrastructure can cater for. Thus leads new investment in managers, new technology or machines.

At this point you might be thinking “ every company should just produce until they hit their max efficient point and begin to get constant returns to scale.” This isn't exactly the right way to go about it because whilst economies of scale might tell companies at what output they will be most efficient it does not factor into that calculate the cost of becoming efficient e.g investments in new staff, machines etc and it doesn't factor in what the current demand is.

Companies must produce🛵🛴 to meet demand rather than produce to be efficient. If the point of efficiency is way beyond the demand then a company cannot be efficient. This is unfortunately the case with most small businesses and the reason why big brands and businesses which serve a wider market are always more competitive. Except your pies and cakes taste much better of course!

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What are Economies of Scale? And why you should care🗺
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