Economies of Scale

Summary: A firm's achieving of internal economies of scale would enable it to obtain higher profits due to the incorporation of lower average costs. Various strategic methods exist in order to achieve this, such as buying in bulk. External factors that may affect a firm's long run average cost include improved transport facilities, access to cheaper power and infrastructure, and increased government regulation. (3.2 pages / 962 words) Read Essay

Internal economies of scale refer to a firm's large scale of production in order to minimise costs. Achieving internal economies of scale would mean that the firm would be enable to obtain higher profits due to the low average costs that are incorporated. In order to do this, a firm must implement various strategical methods in order to ensure that it can maximize its profits, including 'bulk buying'. There are a number of external factors which may affect a firm's LAC (Long run average) cost. Some of these factors include improved transport facilities, access to cheaper power and infrastructure, and increased government regulation.

Where a firm needs to achieve a large scale level of production before it can minimise costs is known as economies of scale. Economies of scale reflect the advantage for a firm which are experiences as a firm increases its level of output. Economies of scale are reached when average cost per unit of production fall as the size of output grows. Average cost is the per unit cost of production, obtained by dividing the total cost of producing a certain level of output by the quantity of total output.

Increased specialisation and division of labour will benefit a firm due to the fact that the productivity of the firm will increase. With increased specialisation, a less amount of labour will be required, and hence the cost for hiring labour will subsequently decline. With people specialising in certain sectors of the business, their levels of experience and expertise will also increase. This will result in a greater amount of output being produced and of a better quality.

As firms become larger and their scale of operations increases, they are able to experience reductions in their average costs of production. Large businesses will require to purchase a greater amount of products (buying in bulk) that they will generally be acquired to a smaller cost for each of the inputs purchase. The firm is said to be experiencing increasing returns to scale. Increasing returns to scale results in the firm's output increasing at a greater proportion than its inputs and hence its total costs. As a consequence, its average costs fall.

Purchasing waste materials will reduce the cost for inputs, e.g. food processing waste and fish processing waste may be beneficial use as soil conditioner or stock food. Since waste materials are usually discarded of, a smaller cost will be acquired from the supplier and hence costs are reduced.

Large firms can put resources into research and development, which can expand new production lines, and further per unit costs in the future by implementing improved production techniques. A larger firm can invest in human capital, improving the skills of its labour force through training programs that are specifically tailored for the firm's needs.

The LRAC curve shows the minimum per unit cost of producing each possible level of output after the firm has had enough time to alter the scale of its plant. The curve is inversely proportional,