Diseconomies Of Scale

Loading the player...

What does 'Diseconomies Of Scale' mean

Diseconomies of scale is an economic concept referring to a situation in which economies of scale no longer functions for a firm. With this principle, rather than experiencing continued decreasing costs and increasing output, a firm sees an increase in marginal costs when output is increased. Diseconomies of scale can occur for various of reasons, but the root cause usually comes from the difficulty of managing an increasingly large workforce.

Diseconomies Of Scale

BREAKING DOWN 'Diseconomies Of Scale'

Diseconomies of scale specifically come about due to three reasons. The first is a situation of overcrowding, where employees and machines get in each other's way, lowering operational efficiencies. The second situation arises when there is a greater level of operational waste, due to a lack of proper coordination. The third and final reason for diseconomies of scale happens when there is a mismatch between the optimum level of outputs between different operations. Essentially, diseconomies of scale is the result of the growing pains of a company after it's already realized the cost-reducing benefits of economies of scale.

Examples of Diseconomies of Scale

An overcrowding effect within an organization is often the leading cause of diseconomies of scale. This happens when a company grows too quickly, thinking that it can achieve economies of scale in perpetuity. If, for example, a company is able to reduce the per unit cost of its product each time it adds a machine to its warehouse, it might think that maxing out the number of machines is a great way to reduce costs. However, if it takes one person to operate a machine, and 50 machines are added to the warehouse, there is a good chance that these 50 additional employees will get in each other's way and make it harder to produce the same level of output per hour. This increases costs and decreases output.

Sometimes, diseconomies of scale happen within an organization when a company's plant cannot produce the same quantity of output as another related plant. For example, if a product is made up of two components, gadget A and gadget B, diseconomies of scale might occur if gadget B is produced at a slower rate than gadget A. This forces the company to slow the production of gadget A, increasing its per unit cost.

Finally, as output increases, the logistical costs of transporting goods to distant markets can increase enough to offset any economies of scale. For example, when a firm has a plant capable of producing a large output in one location, the more the firm produces at that plant, the more it needs to ship the product to distant locations, increasing certain costs rather than decreasing them.