Economies Of Scale


DEFINITION of 'Economies Of Scale'

Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs; i.e. the greater the quantity of a good produced, the lower the per-unit fixed cost because these costs are shared over a larger number of goods. Economies of scale may also reduce variable costs per unit because of operational efficiencies and synergies. Economies of scale can be classified into two main types: Internal – arising from within the company; and External – arising from extraneous factors such as industry size.


Loading the player...

BREAKING DOWN 'Economies Of Scale'

“Economies of scale” is a simple concept that can be demonstrated through an example. Assume you are a small business owner and are considering printing a marketing brochure. The printer quotes a price of $5,000 for 500 brochures, and $10,000 for 2,500 copies. While 500 brochures will cost you $10 per brochure, 2,500 will only cost you $4 per brochure. In this case, the printer is passing on part of the cost advantage of printing a larger number of brochures to you. This cost advantage arises because the printer has the same initial set-up cost regardless of whether the number of brochures printed is 500 or 2,500. Once these costs are covered, there is only a marginal extra cost for printing each additional brochure.

Economies of scale can arise in several areas within a large enterprise. While the benefits of this concept in areas such as production and purchasing are obvious, economies of scale can also impact areas like finance. For example, the largest companies often have a lower cost of capital than small firms because they can borrow at lower interest rates. As a result, economies of scale are often cited as a major rationale when two companies announce a merger or takeover.

However, there is a finite upper limit to how large an organization can grow to achieve economies of scale. After reaching a certain size, it becomes increasingly expensive to manage a gigantic organization for a number of reasons, including its complexity, bureaucratic nature and operating inefficiencies. This undesirable phenomenon is referred to as "diseconomies of scale".

Want to know more? Read What Are Economies Of Scale?

  1. Takeover

    A corporate action where an acquiring company makes a bid for ...
  2. Fixed Cost

    A cost that does not change with an increase or decrease in the ...
  3. Economic Value Added - EVA

    A measure of a company's financial performance based on the residual ...
  4. Economies of Scope

    An economic theory stating that the average total cost of production ...
  5. Diseconomies Of Scale

    An economic concept referring to a situation in which economies ...
  6. Merger

    The combining of two or more companies, generally by offering ...
Related Articles
  1. Stock Analysis

    4 Things to Watch in the Cable Industry's Consolidation

    Learn about the high-profile purchases being made of cable companies and how these signal the future consolidation of the cable industry.
  2. Stock Analysis

    Analyzing Porter's 5 Forces on Facebook

    Read about how you can use Porter's five forces to analyze Facebook's competition. This simple methodology looks at several different factors or forces.
  3. Savings

    Why Organic Food Is So Expensive

    Discover how organic farmers face many obstacles. Learn why your organics cost so much more than conventional foods and if there is any hope for falling prices.
  4. Stock Analysis

    Top Stocks to Get into Iron Ore Mining

    Learn about the two best stocks to get into iron ore mining. Iron ore is a cyclical industry so the balance sheet is an important concern.
  5. Stock Analysis

    Southwest Airlines: Delta's Worst Enemy?

    Learn about the rivalry between Southwest Airlines and Delta. For decades, Delta was the major operator in the South, but it has been displaced by Southwest.
  6. Fundamental Analysis

    Mergers And Acquisitions: Understanding Takeovers

    In the dramatic world of M&As, battleground terms meld with bizarre metaphors to form the language of the game.
  7. Markets

    Great Company Or Growing Industry?

    Look at the big picture when choosing a company - what you see may really be a stage in its industry's growth.
  8. Investing News

    The Appeal Of Company Spinoffs

    Companies are increasingly turning to spinoffs for a variety of reasons, including improving performance.
  9. Investing

    Explaining Economies Of Scale

    Is bigger always better? Learn about the important and often misunderstood concept of economies of scale.
  10. Economics

    What Are Economies Of Scale?

    Is bigger always better? Read up on the important and often misunderstood concept of economies of scale.
  1. What does it mean when a utility company has a natural monopoly on a market?

    In economics, a natural monopoly is defined as an industry in which production by a monopolistic company is much cheaper ... Read Full Answer >>
  2. How does a company decide whether it is in a position to diversify its offerings, ...

    A company decides whether it is in a position to diversify its offerings based on economies of scope through an analysis ... Read Full Answer >>
  3. How does specialization help companies achieve economies of scale?

    Economies of scale is an economic concept that describes growth in output such that the costs incurred during production ... Read Full Answer >>
  4. What are foundry companies in the electronics sector?

    Foundry companies produce semiconductor chips for third-party manufacturers. Microchip companies utilize foundry services ... Read Full Answer >>
  5. What is the difference between economies of scope and economies of scale?

    Economies of scope and economies of scale are two different economic concepts used to help cut a company's cost. Economies ... Read Full Answer >>
  6. What are the key barriers to entry for companies in the electronics sector?

    The electronics industry includes consumer electronics, specialized electronics for other industries and component parts ... Read Full Answer >>
  7. How do "factor endowments" impact a country's comparative advantage?

    Factor endowments impact a country's comparative advantage by affecting the opportunity cost of specializing in producing ... Read Full Answer >>
  8. How do fixed and variable costs each affect the marginal cost of production?

    The total cost of a business is comprised of fixed costs and variable costs. Fixed costs and variable costs affect the marginal ... Read Full Answer >>
  9. What impact has robotic production had on profitability in the automotive sector?

    Robotic production has grown tremendously in the United States since the 1920s, when automobile factories first began automating ... Read Full Answer >>
  10. What are some real life examples of absolute advantage?

    Absolute advantage is fairly simple to identify in theory, but it can be difficult to tease out in practice. Even with the ... Read Full Answer >>
  11. How does volume relate to economies of scale?

    An economy of scale is the cost advantage that a company has with the increased size of output of a good or service. There ... Read Full Answer >>
  12. What strategies do companies use to regain market share they have lost?

    There are three key ways companies regain market share once it has been lost: pricing changes, promotional changes and product ... Read Full Answer >>
  13. Is it better for a company to have fixed or variable costs?

    It is not necessarily better or worse for a company to have either fixed costs or variable costs. In fact, most companies ... Read Full Answer >>
  14. How is break-even analysis affected by economies of scale?

    Break-even analysis is used to determine when revenue of a good sold equals the cost of the good sold. The break-even point ... Read Full Answer >>
  15. What strategies do companies employ to increase market share?

    Companies increase market share through innovation, strengthening customer relationships, smart hiring practices and acquiring ... Read Full Answer >>
  16. How many nations must a company trade in to be considered a multinational corporation?

    A company only needs to trade in more than one country to be considered a multinational corporation. The largest multinational ... Read Full Answer >>
  17. What is a diseconomy of scale and how does this occur?

    In economics, diseconomies of scale describes the phenomenon that occurs when a firm experiences increasing marginal costs ... Read Full Answer >>
  18. What are the major differences between a monopoly and an oligopoly?

    A monopoly and an oligopoly are economic market structures where there is imperfect competition in the market. A monopoly ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  2. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  3. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  4. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  5. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
  6. Indemnity

    Indemnity is compensation for damages or loss. Indemnity in the legal sense may also refer to an exemption from liability ...
Trading Center