Distinguish between economies and diseconomies of scale, giving examples of each.

Expert Answers

An illustration of the letter 'A' in a speech bubbles

Scale means to expand. When we talk about economies of scale, we refer to the benefits that a firm receives as it grows. Diseconomies of scale is the opposite—it refers to the disadvantages of scaling.

Take the example of a big company like Nike. It is a recognized brand that...

Unlock
This Answer Now

Start your 48-hour free trial to unlock this answer and thousands more. Enjoy eNotes ad-free and cancel anytime.

Start your 48-Hour Free Trial


Scale means to expand. When we talk about economies of scale, we refer to the benefits that a firm receives as it grows. Diseconomies of scale is the opposite—it refers to the disadvantages of scaling.

Take the example of a big company like Nike. It is a recognized brand that makes billions in global sales every year. If Nike wants to expand to a new market but they don’t have the capital, they can simply go to the bank and ask for a loan. Since the brand is big and makes huge sales every year, the bank will approve the loan within a short period. The lender can also give Nike credit at a cheaper rate because they want them to return. The discounted bank loan is an example of economies of scale. Nike pays a lower interest rate on the loan because of its size. The bank believes that such a company is unlikely to default.

Scaling can also be bad for a company. Take the example of a company like AT&T. It is currently the largest telecommunications company in the world. The firm grew by buying out competitors and acquiring their staff and technology. Because of its sheer size, the quality of services offered by AT&T has been dwindling. There are numerous complaints from At&T users about poor customer service. Since the company has a large workforce, it cannot monitor the actions of all its employees. The lack of motivation from AT&T workers is an example of diseconomies of scale.

Approved by eNotes Editorial Team
An illustration of the letter 'A' in a speech bubbles

Economies of scale are the cost benefits that a business acquires due to the amount of output or size of the operations. The underlying principle stipulates that as the number of outputs increase then the fixed cost is distributed equally among each unit, reducing the cost per unit with an increase in the number of units. This in turn offers an opportunity for the business to improve its profit margin.

Dis-economies of scale can be referred to as the opposite of economies of scale or a point in the scale where the business stops obtaining the cost benefits characterized by increased output or expansive operations. In this case, the unit cost per output increases with an increase in a single output unit.

An example of economies of scale occurs when a business buys in bulk in order to accrue higher discounts thus reducing unit costs.

An example of dis-economies of scale occurs when the business buying in bulk incurs higher costs per unit regardless of discounts offered because these cost benefits are offset by transportation costs.

Approved by eNotes Editorial Team
An illustration of the letter 'A' in a speech bubbles

Economies of scale is the phenomena where organizations achieve better results (lower costs) with an increase in production and scale of operations. In simpler terms, the higher the production, the lower the cost. This is especially true for cases where the fixed cost component (such as capital cost of installation and equipment, etc.) is high. In such a scenario a higher output simply translates to lower cost per unit item.

Diseconomies of scale is the exact opposite, where items are produced at higher per unit cost, that is economies of scale no longer work at higher production. This may be due to higher transportation or storage cost of products. 

An example is large retailers like Walmart. The cost of installation and equipment is a one time cost. The running cost is only the wages and maintenance. The more items the store sells, the higher the profit. And since they sell practically everything, they have economies of scale supporting them, that is they sell in bulk and thus small profits add up. 

Another example is the production of mobile phones. Once the research is complete and manufacturing has been perfected, higher production will mean lower per unit cost. This means economies of scale. However, since the mobile phone market sees new additions every few months, any new model will have to produce just enough to satisfy the demand and last till the later model is introduced. So a very high output (more than the demand) may actually mean higher inventory cost and then diseconomy of scale will set in.

Approved by eNotes Editorial Team
An illustration of the letter 'A' in a speech bubbles

Economy of scale is the principle that the per unit cost of producing a good is lower when one produces that good in greater quantity.  Diseconomy of scale provides the opposite outcome, that being a higher cost per unit when fewer of a good are produced.  This principle is premised upon the idea that there are constant costs associated with the production of goods, for example, the cost of equipment, some minimum human resource cost, utitility costs, and so on.  That constant cost, if distributed over more goods, results in a lower cost per unit, while that cost, if distributed over fewer goods, results in a higher cost per unit.

If I am producing metal chairs, I need a plant, with heat, light, and water, machinery to produce the chairs, and people to run the machinery.  Supposing that those fixed costs are about $5,000 per month, if I produce 1000 chairs during that month, each costs me $5.00 to make.  If I only produce 500 chairs during that month, each costs me $10.00 to make.  Assuming that the price of each chair is $15.00, we can see that our profitability is going to improve significantly if we make more chairs, all other things being equal. 

Approved by eNotes Editorial Team