Economies of scale occur when its Long Run Average Costs fall with increasing output.
Therefore increasing production leads to increasing returns to scale and there is greater efficiency.
Diagram of Economies of Scale
Increasing output from Q2 to Q1, we see a decrease in long run average costs
Economies of Scale occur for various reasons.
1. Specialization and division of labour:
In large scale operations workers can do more specific tasks. With little training they can become very proficient in their task, this enables greater efficiency. A good example is an assembly line with many different jobs.
Some production processes require high fixed costs e.g. building a large factory. If a car factory was then only used on a small scale it would be very inefficient to run. By using the factory to full capacity average costs will be lower.
3. Bulk buying:
If you buy a large quantity then the average costs will be lower. This is because of lower transport costs and less packaging. This is why supermarkets get lower prices from suppliers than local corner shops.
4. Spreading overheads.
If a firm merged it could rationalise its operational centres. E.g. it could have one head office rather than two.
5. Risk Bearing economies.
Some investments are very expensive and perhaps risky, therefore only a large firm will be able and willing to undertake the necessary investment. E.g. pharmaceutical industry needs to take risks in developing new drugs
6. Marketing Economies of scale.
There is little point a small firm advertising on a national TV campaign because the return will not cover the high sunk costs
7. The container principle.
To increase capacity 8 fold it is necessary to increase surface area only 4 fold.
8. Financial economies.
A bigger firm can get a better rate of interest than small firms
9. External economies of scale:
This occurs when firms benefit from the whole industry getting bigger. E.g. firms will benefit from better infrastructure, access to specialized labour and good supply networks. E.g. micro chip producers often set up in Silicon valley
Internal Economies of Scale.
Most of the above economies of scale are internal. It means the economies benefit the firm when it grows in size
Studies in Economies of Scale
Studies in Economies of Scale suggest that to attain the lowest point on the Long run average costs the minimum number of cars to be produced in 1 year is 400,000