Posted: May 31st, 2021
Economies of scale is an important concept for business managers. Economies of scale refers to a situation when long run average cost declines as the firm produces more output. Average cost is defined as total cost divided by the total quantity of the product produced. Therefore, average cost is the per unit cost of production. Thus, economies of scale implies that the firm’s per unit cost of production falls as the firm produces more output. The opposite of this is called diseconomies of scale. This occurs when long run average costs increase as the firm produced more output.
Experiencing economies of scale is very advantageous to business firms because it means that the firm will be able to capture a larger share of the market. Furthermore, this represents a barrier to entry because new entrants will not be able to match the low per unit cost of production enjoyed by the existing firms that already produce a large output. In the extreme case a firm might be a natural monopoly. A natural monopoly is a firm that experiences economies of scale throughout the entire range of market demand. Therefore, average cost is minimized when only a single firm produces the entire market output in the case of a natural monopoly.
As the name suggests, the way to achieve economies of scale is by increasing the scale of the business. This means increasing all of the firm’s inputs including building space and physical capital. If economies of scale are available to the firm, then increasing the scale of production will allow the firm to take advantage of the economies of scale. A larger scale of production provides increased opportunities for the specialization of labor, capital, and managerial resources, and this is a major source of economies of scale.
However, increasing the scale of production is not guaranteed to produce economies of scale, and could produce the opposite. Increasing the scale of the business could result in diseconomies of scale in which average costs increase as more output is produced. This can result from the difficulty that comes with coordinating the activities of a large organization.
AudoEdge can determine whether it is experiencing economies of scale or diseconomies of scale based on what is happening to the average cost of production as output changes. If the average cost of production is falling as more output is being produced then the firm is experiencing economies of scale, and if the average cost of production is rising as more output is produced then the firm is experiencing diseconomies of scale.
Efficiency is something that every business and company should strive for. By creating an efficient environment and process, companies can focus their time and energy elsewhere to ensure they have a smooth-running business. AutoEdge needs to be operating at a high level to be able to be working at a high level of efficiency. In order to achieve this, AutoEdge should be conducting a SWOT analysis so it can determine how to better conduct their operations, thus being able to obtain economies of scale with its production.
Investopedia (n.d.) explains that “SWOT analysis is a framework used to evaluate a company’s competitive position by identifying its strengths, weaknesses, opportunities and threats. Specifically, SWOT analysis is a foundational assessment model that measures what an organization can and cannot do, and its potential opportunities and threats”. By utilizing a SWOT analysis, AutoEdge can determine its position within its business community. Not just internally to the company, but also externally when it comes to their competitors. You cannot properly measure your level of output unless it is compared to that of your competition in your field. This analysis can then, in turn, help AutoEdge determine whether they have obtained economies of scale.
The textbook (Keat, Young, & Erfle) says that “ economies of scale essentially means that a company’s average cost decreases at higher levels of output” (2013). For AutoEdge to achieve economies of scale, they would have to be efficiently producing their product to increase its level of output, so that in the long run, they can lower their average costs. Their average costs could essentially be any type of costs (i.e. operating costs or salary costs), but the overall goal is to lower AutoEdge’s average costs. By doing a SWOT analysis and measuring efficiency, AutoEdge is setting themselves up for success in the long run so they can continue to stay around for years to come. But on the other side of this, all of these measures can be used to see if AutoEdge has achieves diseconomies of scale, which simply means that costs increase as output is increased too. Basically, a company grows too large too fast and they cannot keep up with it, so they have to raise the cost per unit of whatever is being produced. But AutoEdge should have no problem determining which end of the spectrum they are on if they utilize a SWOT analysis to measure their efficiency.
Place an order in 3 easy steps. Takes less than 5 mins.