CIMA BA1 Syllabus B. Microeconomic And Organisational Context Of Business - Economies Of Scale - Notes ^{1 / 9}

= decreasing cost per unit

Internal economies of scale

Internal economies of scale arise from the firm, either through its own growth or potentially from growth by acquisition. 

This is the type of economy of scale that is under the control of management.

Trading economies of scale (internal)

1. Buying economies 

   -  reducing the cost of material purchases through bulk purchase discounts

2. Bulk selling 

   - will enable a large firm to make relative savings in distribution costs and advertising costs

3. Economies of scope 

   - refer to the cost savings available by offering a wider range of products,

Financial economies of scale (internal)

It may be cheaper and easier for large firms to raise finance. 

Investors accept lower returns if risk is lower. 

Larger firms are perceived to be less risky because they often have:

• Valuable assets to use as security

• High levels of market power

• Less reliance on a single product or market

Technical economies of scale (internal)

A high proportion of costs are fixed costs 

eg aircraft manufacture, car manufacture, logistics companies.
 
In these industries, larger firms may have a significant cost advantage because the fixed costs can be spread over a larger number of units.

Illustration 1

Cow Co and Calves Co produce Bottles of milk. 

Storage cost is $10 million for both companies. 

The average variable cost for both companies, is $0.1 per bottle. 

Average costs per unit will be:

Cow Co will therefore have a significant cost advantage over Calves Co.

Managerial economies of scale (internal)

The number of management and supervisory staff does not increase at the same rate as output

• For example a hotel with 10 bedrooms and a hotel with 100 bedrooms would each have a single General Manger and Head Chef.

External economies of scale

It is also possible for costs per unit to fall because of a growth in the size of the industry (not the firm). 

Here are some examples:

• To support a growing industry, the government may provide educational services that are geared towards training new entrants. 

  This saves firms in the industry from having to incur the costs of training.

• Government assistance may be granted to industries that promise large amounts of jobs or export earnings. 

  In recent years, information technology, green energy and biotechnology industries have benefited from this.