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Journal Information Current issues are now on the Chicago Journals website. Read the latest issue.Established in 1958, The Journal of Law and Economics publishes research on a broad range of topics including the economic analysis of regulation and the behavior of regulated firms, the political economy of legislation and legislative processes, law and finance, corporate finance and governance, and industrial organization. The Journal has published some of the most influential and widely cited articles in these areas. Publisher Information Since its origins in 1890 as one of the three main divisions of the University of Chicago, The University of Chicago Press has embraced as its mission the obligation to disseminate scholarship of the highest standard and to publish serious works that promote education, foster public understanding, and enrich cultural life. Today, the Journals Division publishes more than 70 journals and hardcover serials, in a wide range of academic disciplines, including the social sciences, the humanities, education, the biological and medical sciences, and the physical sciences. Rights & Usage This item is part of a JSTOR Collection. Cost benefits from higher output levels What are Economies of Scale?Economies of scale refer to the cost advantage experienced by a firm when it increases its level of output. The advantage arises due to the inverse relationship between the per-unit fixed cost and the quantity produced. The greater the quantity of output produced, the lower the per-unit fixed cost. Economies of scale also result in a fall in average variable costs (average non-fixed costs) with an increase in output. This is brought about by operational efficiencies and synergies as a result of an increase in the scale of production. Economies of scale can be realized by a firm at any stage of the production process. In this case, production refers to the economic concept of production and involves all activities related to the commodity, not involving the final buyer. Thus, a business can decide to implement economies of scale in its marketing division by hiring a large number of marketing professionals. A business can also adopt the same in its input sourcing division by moving from human labor to machine labor.  Key Highlights
Effects of Economies of Scale on Production Costs
Image: CFI’s Financial Analysis Courses The graph above plots the long-run average costs (LRAC) faced by a firm against its level of output. When the firm expands its output from Q1 to Q2, its average cost falls from C1 to C2. Thus, the firm can be said to experience economies of scale up to output level Q2. In economics, a key result that emerges from the analysis of the production process is that a profit-maximizing firm always produces that level of output which results in the lowest average cost per unit of output. Types of Economies of Scale1. Internal Economies of ScaleThis refers to economies that are unique to a firm. For instance, a firm may hold a patent over a mass production machine, which allows it to lower its average cost of production more than other firms in the industry. 2. External Economies of ScaleThese refer to economies of scale enjoyed by an entire industry. For instance, suppose the government wants to increase steel production. In order to do so, the government announces that all steel producers who employ more than 10,000 workers will be given a 20% tax break. Thus, firms employing less than 10,000 workers can potentially lower their average cost of production by employing more workers. This is an example of an external economy of scale – one that affects an entire industry or sector of the economy. Sources of Economies of Scale1. PurchasingFirms might be able to lower average costs by buying the inputs required for the production process in bulk or from special wholesalers. By negotiating with suppliers for volume discounts, the purchasing firm takes advantage of economies of scale. 2. ManagerialFirms might be able to lower average costs by improving the management structure within the firm. The firm might hire better skilled or more experienced managers. 3. TechnologicalA technological advancement might drastically change the production process. For instance, fracking completely changed the oil industry a few years ago. However, only large oil firms that could afford to invest in expensive fracking equipment could take advantage of the new technology. Diseconomies of ScaleImage: CFI’s Financial Analysis Courses Consider the graph shown above. Any increase in output beyond Q2 leads to a rise in average costs. This is an example of diseconomies of scale – a rise in average costs due to an increase in the scale of production. As firms get larger, they grow in complexity. Such firms need to balance the economies of scale against the diseconomies of scale. For instance, a firm might be able to implement certain economies of scale in its marketing division if it increased output. However, increasing output might result in diseconomies of scale in the firm’s management division. Frederick Herzberg, a distinguished professor of management, suggested a reason why companies should not blindly target economies of scale: “Numbers numb our feelings for what is being counted and lead to adoration of the economies of scale. Passion is in feeling the quality of experience, not in trying to measure it.” Video Explanation of Economies of ScaleWatch this short video to quickly understand the main concepts covered in this guide, including the definition of economies of scale, effects of EOS on production costs, and types of EOS. Additional ResourcesThank you for reading CFI’s guide on Economies of Scale. To keep learning and advancing your career, the following resources will be helpful:
Which of the following is not a reason a firm might experience economies of scale?The correct answer is A. As output increases, managers can begin to have difficulty coordinating the operations of their firms. This is NOT a reason for economies of scale because this difficulty would cause the average production time to increase, which would cause the average cost to increase as output increases.
What are the 3 reasons for economies of scale?First, specialization of labor and more integrated technology boost production volumes. Second, lower per-unit costs can come from bulk orders from suppliers, larger advertising buys, or lower costs of capital. Third, spreading internal function costs across more units produced and sold helps to reduce costs.
What is one reason that a firm may experience economies of scale?Economies of scale are cost advantages that can occur when a company increases their scale of production and becomes more efficient, resulting in a decreased cost-per-unit. This is because the cost of production (including fixed and variable costs) is spread over more units of production.
Which of the following is a reason for economies of scale quizlet?Economies of scale can result from a variety of factors, including: -lower costs of inputs as firms purchase larger quantities. - productivity gains from more specialized labor. amount of output produced per unit of a resource employed.
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Which of the following is not a reason why firms experience economies of scale?
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