An Introduction to Economies & Diseconomies of Scale
- As a firm grows, it is able to increase its scale of output, generating efficiencies that lower its average costs (AC) of production
- These efficiencies are called economies of scale
- Economies of scale help large firms lower their costs of production beyond what small firms are able to achieve
- As a firm continues to increase its scale of output, it will reach a point where its average costs (AC) will start to increase
- The reasons for the increase in average costs are called diseconomies of scale
- The reasons for the increase in average costs are called diseconomies of scale
- Economies of scale are the reason that firms generate increasing returns to scale in the long run
- Diseconomies of scale are the reason that firms experience decreasing returns to scale in the long run
Diagram: Long-run Average Cost Curve
Economies of scale occur when average costs decrease with increasing output, and diseconomies of scale occur when average costs increase with increasing output
Diagram analysis
- With relatively low levels of output, the firms average costs are high
- As the firm increases its output, it begins to benefit from economies of scale, which lower the average cost per unit
- At some level of output, a firm will not be able to reduce costs any further; this point is called productive efficiency
- Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale