Large firms in an industry have cost advantages over small firms in same industry.Explain condition for this statement to be true. cost advantage

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pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

I think what you are asking about in this question is what is called economies of scale.  Economies of scale exist when large firms in an industry have lower costs per unit produced than small firms in that same industry have.

In order for economies of scale to occur, firms must experience high fixed costs even when they are small.  If fixed costs are high, large companies will experience economies of scale because they will be able to produce more per dollar of fixed costs -- the small firms will have very high average fixed costs while large firms have lower average fixed costs because they produce a larger number of units of their product.

krishna-agrawala's profile pic

krishna-agrawala | College Teacher | (Level 3) Valedictorian

Posted on

Large firms tend to have cost advantage over smaller firms engaged in supplying the same product because of the economy of scale enjoyed by larger firms.

Economy of scale refers to the reduction in per unit cost of a product because of the economies achieved because of higher level of production. Such economies of scale my accrue to a firm due to various factors such as higher utilization of manpower and capital equipment, lower raw material prices because of quantity discounts, the fixed overhead costs getting distributed over a larger production, and use more economical mass production technology.

However it must be noted that not all industries offer equal scope for economy of scale. Also for any given product there is a limit to which economy of scale can be achieved. Raising production beyond an optimum level can increase per unit cost.

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