ib business and management 1.6 – economies and diseconomies of scale
TRANSCRIPT
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IB Business and Management
1.6 – Economies and Diseconomies of Scale
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Learning Outcomes
• Apply the concepts of Economies and Diseconomies of Scale to business decisions
• Evaluate the relative merits of small versus large organisations
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What are Economies of Scale?
• Economies of scale occur when the average unit cost to produce each unit falls as the firm gets larger
Tip: It is ‘unit costs’ that will decrease NOT total costs
In what ways is this a huge benefit to large businesses?
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Types of Economy
• Internal Economies – those economies that come from within the firm
• External Economies – those economies that occur within a whole industry
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Types of Internal Economies
There are 7 types of economies of scale:•Purchasing•Marketing•Managerial•Financial•Technical•Specialisation •Monopsony
What can you tell me about any of these different types of
economy?
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Purchasing Economies
• Larger firms buy materials in larger amounts
• They will get discounts from suppliers for large orders
• This is called bulk-buying• The cost per unit will be lower
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Marketing Economies• Advertising and marketing can be a huge
expense for a business• The more items a company sells the more
units this cost can be spread over• Eg. A company places an advert which costs
£1,000. 500 units are sold this is £2 per item. If 2000 are sold this is 50p per item
• Businesses also benefit from being able to sell in bulk. Admin costs and distribution costs will be cheaper per unit
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Managerial Economies
• In small businesses one manager will often have to fulfill many functions
• In larger firms, managers can specialise which means that they can be expert in their area of work and therefore more efficient
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Financial Economies
• Large companies are seen to be less of a credit risk than small companies
• Banks will tend to lend to bigger companies at lower rates of interest
• Also cheaper sources of finance such as trade credit are more widely available
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Technical Economies
• Large businesses are more likely to be able to afford more sophisticated machinery
• They will also use any machinery more effectively• In small businesses machinery may lay unused
for most of the day whereas in a larger firm it may be used nearer to full capacity
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Specialisation Economies
• Similar to managerial economies• Other workers can also specialise.• This is called ‘division of labour’• Workers develop expertise in their
particular area of the business, resulting in greater productivity
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Monopsony Economies
• Similar to purchasing economies• Specifically refers to large firms being in a
strong buying position.• They can negotiate with suppliers for even
larger discounts and suppliers want their custom badly
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What type of economy?
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The business hires a full time accountant to deal with the business finances
Question 1
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Conveyor belts & specialised machinery are purchased for producing in huge numbers
Question 2
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Large businesses have more power to negotiate prices down with suppliers as their custom is important
Question 3
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One advert can sell 100,000 items or 100 items – the cost is the same
Question 4
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Using CAD speeds up the design process
Question 5
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HSBC offer a lower rate of interest to bigger businesses who they consider to be less of a risk
Question 6
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Printing leaflets to advertise the business costs $100 for 1000 leaflets but only $200 for 10,000
Question 7
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HSBC offer a lower rate of interest to bigger businesses who they consider to be less of a risk
Question 8
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When buying large quantities of goods, the price per unit is cheaper
Question 9
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Workers and managers can specialise in one area which means they will be more productive
Question 10
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Fixed delivery costs are spread over a larger number of items
Question 11
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Trade Credit and other cheap forms of finance might be available to larger firms
Question 12
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Machines can do work more quickly and with less mistakes and wastage
Question 13
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External Economies of scale….
Where falling average costs occur due to the whole industry growing
(particularly in a certain area)
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External Economies
• Skilled Labour• Suppliers and Ancillary Services• Cooperation
How could each of these lead to decreased unit costs?
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BUT…….
Sometimes larger businesses may suffer from diseconomies of scale ……..
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Unit Costs- GraphC
ost
Per
Un
it
Output
Economies of scaleReducing unit costs
Lowest Unit Costs
Diseconomies of scaleOutweighing economies
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Question
• Why might ‘unit costs’ start to increase again?
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Diseconomies of Scale
• Where average unit costs rise as the business grows larger
• Diseconomies of scale tend to occur because it is more difficult to manage a large business than a small one
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Examples of Internal Diseconomies of Scale
• Bureaucracy• Poorer Labour relations• ‘Small fish in a big pond’ • Communication difficulties• Lack of Control and Coordination• Too much specialisation demotivates
workers• Complacency• How could these factors lead to an
increase in average unit costs?
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External Diseconomies
• Land scarcity leading to increased rents• Traffic congestion• Pressure to increase wages to attract new
workers
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IS GROWTH ALWAYS DESIRABLE?
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Questions…..
• Do all firms want to grow?• Why do we still have small firms?• What disadvantages might there be of
being a big firm?
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Why do we still have small firms?
PersonalService
Greater Flexibility
No motivation to grow
Lower Costs Cost
LessPaperwork
NewCompanies
NicheMarkets
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Potential problems with growth
• Increased costs• Liquidity problems (if growth is too fast)• Difficulties in communication/coordination• Diseconomies of Scale