Distinguish between economies and diseconomies of scale, giving examples of EACH

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Lorraine Caplan | College Teacher | (Level 1) Educator Emeritus

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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. 

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thetall | (Level 3) Educator

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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.

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gsenviro's profile pic

gsenviro | College Teacher | (Level 1) Educator Emeritus

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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.

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