Economy of Scale

by Investing School on June 4, 2010

Economies of scale happen when a business expands and it is able to streamline its production costs in the process. There are factors that cause production costs per unit to decrease while the scale is increased. When this happens, this is when economies of scale have been achieved. So, there is an assumption that as a company grows and units of production are increased then it will have a better opportunity to decrease its costs.

Adam Smith, father of modern economics, said that the division of labor and specialization would be the way to achieve a larger return on production. This meant that employees would be able to concentrate on their specific task. This would suppose that over time, the employees skills and proficiency with that particular task would increase which would save time and money all the while production levels are increased.

In addition to specialization and division of labor, a company will have various inputs that may also result in the production of goods or services and where you can find additional economies of scale. They are:

  • Lower input costs: If a company buys in bulk, they are able to take full advantage of volume discounts.
  • Costly inputs: There are some inputs that are initially expensive but their implementation can result in economies of scale over time. For example, marketing and advertising and managerial advice are expensive, however, they can eventually lead to a lowering of the average cost of production and selling through innovation or ideas on efficiency, etc.

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