Economies Of Scale

AAA

DEFINITION of 'Economies Of Scale'

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.

INVESTOPEDIA EXPLAINS '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?

VIDEO

RELATED TERMS
  1. Takeover

    A corporate action where an acquiring company makes a bid for ...
  2. Minimum Efficient Scale

    The smallest amount of production a company can achieve while ...
  3. Economies of Scope

    An economic theory stating that the average total cost of production ...
  4. Economic Value Added - EVA

    A measure of a company's financial performance based on the residual ...
  5. Fixed Cost

    A cost that does not change with an increase or decrease in the ...
  6. Merger

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

    What are the major differences between a monopoly and an oligopoly?

    The major differences between a monopoly and an oligopoly include the number of firms in the market, type of barriers to entry and presence of close substitutes.
  2. 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.
  3. 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.
  4. Investing News

    The Appeal Of Company Spinoffs

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

    What Are Economies Of Scale?

    Is bigger always better? Read up on the important and often misunderstood concept of economies of scale.
  6. Mutual Funds & ETFs

    Corporate Takeover Defense: A Shareholder's Perspective

    Find out the strategies corporations use to protect themselves from unwanted acquisitions.
  7. Insurance

    The Wonderful World Of Mergers

    While acquisitions can be hostile, these varied mergers are always friendly.
  8. Economics

    Where is cost of living lowest in the world?

    Learn how the cost of living is the lowest in India based on numbers derived from the CPI and organizations like Expatistan and Numbeo.
  9. In recent years, companies have discovered that there are limits to the gains created by having all major business activities in one organization.
    Investing Basics

    Why do companies decide to unbundle their lines of business?

    In recent years, companies have discovered that there are limits to the gains created by having all major business activities in one organization.
  10. Economics

    Economics Basics

    Learn economics principles such as the relationship of supply and demand, elasticity, utility, and more!

You May Also Like

Hot Definitions
  1. Christmas Island Dollar

    The former currency of Christmas Island, an Australian island in the Indian Ocean that was discovered on December 25, 1643. ...
  2. Santa Claus Rally

    A surge in the price of stocks that often occurs in the week between Christmas and New Year's Day. There are numerous explanations ...
  3. Commodity

    1. A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often ...
  4. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  5. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  6. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
Trading Center