Economies of scale are reductions in average costs attributable to production volume increases. They typically are defined in relation to firms, which may seek to achieve economies of scale by becoming large or even dominant producers of a particular type of product or service. A distinction can be made between internal and external economies of scales. Internal economies of scale occur when a firm reduces costs by increasing production. External economies of scale occur when an entire industry benefits from expansion; for example, through the creation of an improved transportation system, a skilled labor force, or by sharing technology.
Economies of scope are reductions in average costs ...view middle of the document...
This reduction in average unit cost continues until the plant gets so big that coordination of material flow and staffing becomes very expensive, requiring new sources of capacity.
This concept can be related to best operating levels by comparing the average unit cost of different sized firms. In many types of production processes, the most efficient types of production facilities are practicable only at high output levels. It is very expensive to build custom-made cars by hand, and would be equally or more expensive to use a large General Motors assembly plant to build just a few Chevrolets per year. However, if the plant is used to build 6 million cars per year, the highly specialized techniques of the assembly line allow a significant reduction in costs per car.
Suppose, for example, that Honda were constrained to produce only 10,000 motorcycles a year instead of a possible 1 million. With this circumstance, the need for an assembly line would become obsolete. Each motorcycle could be produced by hand. Honda could rule out benefits that might be derived from the division and specialization of labor. In producing such a small number, the use of any production techniques that reduce average cost would become obsolete. In these two examples, Honda and General Motors would enjoy economies of scale with reduced average cost simply by increasing the scale of their operations.
More broadly, economies of scale can occur for a number of reasons, including specialization efficiencies, volume negotiating/purchasing benefits, better management of by-products, and other benefits of size that translate into savings or greater profitability for a large-scale producer.
In a small firm, labor and equipment must be used to perform a number of different tasks. It is more difficult for labor to become skilled at any one of them and thereby realize the gains in productivity and reduction in per-unit costs that specialization permits. In the same way, management functions cannot be as specialized in a smaller firm. Supervisors may have to devote time to screening job applicants, a task usually more efficiently handled by a personnel department in a larger firm. Executives may have to divide their attention between finance, accounting, and production functions that could be handled more proficiently by departments specializing in each of these areas in a larger firm.
According to Langlois, some economies of scale result from the specialization and division of labor. Mass production allows the use of specialized equipment and automation to perform repetitive tasks. The larger the output of a product, plant, or firm, the greater will be the opportunities for specialization of labor and capital equipment. Similarly, machinery and equipment cannot be used as efficiently when it has to be switched back and forth between tasks.
Increased specialization in the use of labor is feasible as a plant increases in size. Hiring more workers...