Economies of scale
Economies of scale occur when a firm can lower its unit costs by scaling up production. This means that the more a firm produces, the lower its cost per product becomes. Economies of scale occur because fixed costs are spread over a larger number of units produced and because firms become more efficient as they grow in size. The goal is to gain a competitive advantage by reducing costs and increasing profitability.
How do economies of scale work?
Economies of scale occur when a firm's output increases and the firm is able to reduce its unit costs. This can happen in several ways, such as:
- With more production, fixed costs per unit decrease.
- With growth, companies learn to become more efficient and cut costs.
- Larger companies can buy raw materials more cheaply in bulk.
- Investing in technology, such as automation, lowers production costs.
Types of economies of scale
There are two types of economies of scale:
- Internal economies of scale: These arise within the company itself, such as more efficient production methods, cost savings from bulk purchasing or the use of better technology.
- External economies of scale: These arise outside the company, in the market in which it operates. This can happen when suppliers or service providers become more efficient and reduce costs, which benefits the company. The government may also offer tax breaks for larger companies.
