How Does Economies of Scale Occur

Economies of scale occur when organizations are able to spread their cost over more units of output. When a company grows, the production is likely to increase, allowing the business to reduce its overall cost. The theory holds greater significance when measuring economic growth. Similarly, diseconomies of scale depict inefficiency where production may be less when compared to unit cost.


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    The two key ingredients to achieve larger production incorporate specialization and division of labor.  When a company is operating on a larger scale, workers can indulge in specific tasks. By offering specialized training; they can easily specialize in their relative work, which in turn leads to greater efficiency.

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    The argument can be further split into internal economies of scale and external economies of scale. The former notion will be achieved with the size of the company. Operating on a larger level allows them comparative advantage as they have the ability to buy in bulk. This helps them reduce their unit cost and make larger profits. With that profit, they can hold competitive edge by offering lower prices to consumers. Moreover, the company is able to invest heavily in research and development, marketing and hiring expert professionals. This will increase not efficiency but will further lead to a reduction in average cost of production and selling.

    This then has a positive impact on the organizational structure, where a company is benefiting from a proper chain-of-command, and improvising technically by using new machinery etc. With time, the company learns from its mistake and rectifies them to make the overall process profitable.

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    Let take an example of a large fast food chain. With greater inflow of customers they are bound to make profit. They will buy potatoes in bulk, and get volume discounts. In addition to that, they will invest in research and marketing aspect, and with time will be able lower their assembly cost of producing burgers. After that, they will inculcate new techniques to meet customer demand by setting up drive-thru etc. This in turn allows them to make exuberant amounts of profit and lower their unit production cost.

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    External economies of scale will be realized as transportation cost decreases if the fast-food chain opens up a new franchise in the same location. Also the transfer of technology will be expected, along with the creation of uniform standard across the industry.

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