What are Economies of Scale? Economies of Scale types, sources, significance, and FAQs.

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What are Economies of Scale? 

Economies of scale are cost benefits gained by a business through the scale up of production. This gain is due to the fact that the per unit fixed cost incurred gets distributed over increased units of production. 

The per unit cost and production quantity share an inversely proportional relationship. 

For the increased scale of production, purchasing the material in bulk leads to decreased per unit price and thus adds up to the economies of scale. 

Economies of scale can be seen as a metric that reflects successful production strategies. 

Types Of Economies of Scale  

There are two Economies of Scale: 

Internal Economies of Scale 

These are the unique economies to the organization. They are related to large businesses. 

For example, big companies can afford to purchase in bulk for large scale production which results in lowering the per unit cost of the raw materials. 

Now, this gain in cost can be directly drawn out or it can be put into product improvement to compete in the market. Both are internal economies of scale. 

External Economies of Scale 

It refers to the gain in costs due to external factors. These factors affect the whole industry and not just any few companies. 

For example, tax concessions for those companies that generate mass scale jobs. 

Or if a govt imposes heavy duties on foreign companies then that will benefit the local industry as the competition will decrease. 

Economies of Scale sources 

The sources of gain in costs through economies of scale can be categorised as: 

Purchasing 

Lowering of per unit cost of raw materials by bulk purchasing. Thus saving the costs through scaled up production.

Managerial 

Better cost management and savings through improved managerial structure. 

Technological 

Cost effective technologies that reduce the production costs and scale up the number of units produced.

Significance of Economies of Scale 

Economies of Scale is a very useful metric as it can support your production and sales strategy by indicating the best phase to scale up the production. 

This also helps in cost management. Calculating the economies of scale gives significant information about how to approach and manage production in order to gain the most cost benefits. When to scale up and to what extent can be estimated from data of economies of scale. 

FAQs 

Q: How do you determine economies of scale?

A: If an increase in output units results in a decrease in the per-unit cost of raw materials thereby giving a gain in cost to the firm. This is called economies of scale. 
Cost elasticity value also indicates the existence of economies of scale. If the cost elasticity ratio is less than one then economies of scale exist. 

Q: What are the types of economies of scale? 

A: Economies of scale types are – internal economies of scale and external economies of scale. 
The internal economies of scale are further divided into five types- Technical, Monopsony power, Managerial, Financial, and Network economies of scale.

Q: What are diseconomies of scale?

A: It refers to the overgrowth of a company by economies of scale. 
These are the cost disadvantages that are attributed to scaling up of the production leading to an increase per unit cost. 
It is the stage beyond the saturation of economies of scale due to uncontrolled scale-up of production.

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