Chapter 22: Problem 805

Define the terms economies of scale and diseconomies of scale and explain what they refer to.

Short Answer

Expert verified

Economies of scale refer to the cost advantages a business obtains due to its scale of operation, with cost per unit of output decreasing as the scale increases. It represents operational efficiency as production levels rise. Diseconomies of scale occur when a company grows beyond a certain limit, causing costs per unit to increase due to operational inefficiencies. For example, a clothing manufacturer may experience economies of scale by ordering fabric in bulk, but if it grows too large, managing its workforce and machinery may become challenging, leading to diseconomies of scale.

Step by step solution

Define Economies of Scale

Economies of scale is an economic term referring to the cost advantages that an enterprise obtains due to its scale of operation, with cost per unit of output generally decreasing with increasing scale. It represents the efficiency of operation that a business experiences as it increases its production levels.

Define Diseconomies of Scale

Diseconomies of scale is an economic concept that refers to a situation where economies of scale no longer function for a firm. With this concept, as a business grows beyond a certain limit, the costs per unit will start to increase. This happens when the company becomes too large and operationally inefficient.

Explain Economies of Scale in Further Detail

Economies of scale occur when a firm's average costs decrease while each additional unit of output is produced. There are two types. Internal economies of scale occur within a firm, such as when a company invests in modern machinery that improves production efficiency. External economies of scale occur outside a firm but within its industry, such as when an industry's growth leads to a skilled labor force that benefits all companies within the industry.

Explain Diseconomies of Scale in Further Detail

Diseconomies of scale occur when a company grows so large that the costs per unit increase. It can happen due to a number of reasons like problems with communication since as a firm grows bigger, it becomes more challenging to manage effectively. It could also be due to decreased motivation among employees since it becomes challenging in big firms to take care of all employees' needs.

Provide Examples

For instance, a clothing manufacturing company might experience economies of scale by ordering fabric in bulk, thus reducing the cost per unit of cloth. However, if this company grows too large and begins to experience challenges in managing its large workforce or suffers from problems maintaining its machinery, then it might start to experience diseconomies of scale. By learning and understanding these concepts, one will be able to analyze and understand the correlation between a business's size, production levels, and cost efficiency.