Definition
In the long run all inputs can vary. If long-run average cost falls as output rises there are economies of scale; if it rises there are diseconomies. In production terms it relates to increasing returns to scale, where doubling all inputs more than doubles output.
Sources
- Specialisation: Adam Smith's pin factory shows the gains from dividing tasks.
- Spreading fixed costs such as plant, R&D; and advertising over more units
- Purchasing and financial advantages: bulk discounts and cheaper capital
- Technical factors: capacity of tanks or pipes grows faster than their surface area.
Diseconomies and minimum efficient scale
Very large firms may face higher coordination costs, communication problems and weaker motivation. The output where average cost first reaches its minimum is the minimum efficient scale; the larger it is relative to the market, the fewer firms an industry can support.
Economies of scope
Economies of scope arise when producing several products together costs less than producing them separately. Scale concerns the quantity of one product; scope concerns variety.
Natural monopoly
When scale economies persist across the whole market, as in power grids or water networks, a single supplier is cheapest, so governments regulate prices or use public enterprises. Scale economies in administration and risk pooling are also one argument for compulsory social insurance.
References
- Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations. W. Strahan and T. Cadell.
- Panzar, J. C., & Willig, R. D. (1981). Economies of scope. American Economic Review, 71(2), 268-272.
- Pindyck, R. S., & Rubinfeld, D. L. (2018). Microeconomics (9th ed.). Pearson.
- Mankiw, N. G. (2021). Principles of Economics (9th ed.). Cengage.