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Economies of Scale

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  • Pages: 3
  • Word count: 581
  • Category: Economics

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Economies of scale are an important aspect of efficiency in production .Economies of can henceforth be define as ‘the reduction in average costs of production, that occur as a firm increases in size’.

As businesses grow and their outputs increases,they commonly benefit from a reduction in average costs of production.Total costs will increase with the increase in output,but the cost of producing each unit falls as output increases .The reduction in average cost is what gives larger firms a competitive advantage over small firms .The fall in average costs as output increases are known as Economies of scale. Costs in the short and long run

In the short run costs can be both variable or fixed ,but in the long run all costs become variable.Its this switch to all costs becoming variable that separates the short run from the long run. A good and simple example to help understand the division between short and long run is G4s which offers parcel delivery , They run 3 vans both of which are leased ,with 3yrs to run.The leasing charges of Ksh.s 40000 are fixed for the term of the lease .For the firm the short run will be two years, as part of their costs are fixed for this period of time.If at the end of the two year period they are able to negotiate better leasing terms because they have established the company as a good risk, or bercause they now wish to lease 7 vans, they are benefiting from economies of scale . Alternatively they may wish to buy the new vans or, if things have not gone well, even withdrawal from the business.The fixed costs, until they commit themselves to a new agreement , become variable.

Each firms long run average cost curve is made up of a series of short run average cost curves. As a business grows it moves and from one short run average cost curve, each one being progressively lower and so reducing average costs of output –cheaper leasing of vans.

Internal and external economies of scale.
Economies can be broken down into two broad groups, these are internal and external. Internal Economies of Scale- Reduction in average or unit cost because of increasing internal efficiencies of the firm. External Economies of Scale- Reduction in average or unit cost because of increasing efficiencies of the firm that have resulted from external factors.

Internal Economies of Scale
They include;-
-Managerial economies
Purchasing. As firms grow ,they increase the size of orders for raw materials or components.This will then result in discounts being given ,and the cost of each individual component purchased will fall . This will therefore reduce the average cost of production.

Technical.As businesses grow they are able to use the latest equipment and incorporate new methods of production. This increases efficiency and productivity ,reducing average costs of output.

Financial. As firms grow they will have access to wider range of capital, such as equity capital, this reduces the cost of borrowing for investment.Also as the asset s of the firm grow ,businesses are able to offer more security for borrowing reducing the risk to the lender and reducing the cost of borrowing.

Managerial. As businesses grow they are able to employ specialist managers .These managers will know how to get the best value for
each Ksh.s spent, whether it is in production ,marketing or purchasing.This will increase efficiency,reduce the average costs of producing goods and selling the goods prodused.

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