Economies of scale

In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of time. A decrease in cost per unit of output enables an increase in scale. At the basis of economies of scale, there may be technical, statistical, organizational or related factors to the degree of market control. This is just a partial description of the concept.

As quantity of production increases from Q to Q2, the average cost of each unit decreases from C to C1. LRAC is the long-run average cost

Economies of scale apply to a variety of the organizational and business situations and at various levels, such as a production, plant or an entire enterprise. When average costs start falling as output increases, then economies of scale occur. Some economies of scale, such as capital cost of manufacturing facilities and friction loss of transportation and industrial equipment, have a physical or engineering basis.

The economic concept dates back to Adam Smith and the idea of obtaining larger production returns through the use of division of labor.[1] Diseconomies of scale are the opposite.

Economies of scale often have limits, such as passing the optimum design point where costs per additional unit begin to increase. Common limits include exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry. A common limit for a low cost per unit weight commodities is saturating the regional market, thus having to ship product uneconomic distances. Other limits include using energy less efficiently or having a higher defect rate.

Large producers are usually efficient at long runs of a product grade (a commodity) and find it costly to switch grades frequently. They will, therefore, avoid specialty grades even though they have higher margins. Often smaller (usually older) manufacturing facilities remain viable by changing from commodity-grade production to specialty products.[lower-alpha 1][2]

Economies of scale must be distinguished from economies stemming from an increase in the production of a given plant. When a plant is used below its optimal production capacity, increases in its degree of utilization bring about decreases in the total average cost of production. As noticed, among the others, by Nicholas Georgescu-Roegen (1966) and Nicholas Kaldor (1972) these economies are not economies of scale.


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