ECONOMIES OF

SCALE &
ECONOMIES OF
SCOPE
By: Ayr T.
INTRODUCTION
• Economies
- its all about cost effectiveness

• Scale
- its all about the benefits gained by the
production of large volume of a product.

• Scope
- It is linked to the benefits gained by
producing a wide variety of products by
efficiently utilizing to same operations.
Returns to Scale in Long-run
Production
1. Increasing returns to scale
- When the % change in output >% change in inputs
- Long run average cost will be falling

2. Decreasing returns to scale

- When the % change in output < % change in inputs
- Long run average cost will be rising

3. Constant returns to scale

- When the % change in output = % change in inputs
- Long run average cost will be constant
ECONOMIES OF SCALE
• Refers to a situation where the cost of producing
one unit of a good or service decreases as the
volume of production increases.

• Can be defined as aspects of increasing scale

that lead to falling long-run unit costs.

• Spreads total costs over a greater range of

output
Classification of Economies of Scale
• Internal – arise from the growth of the firm itself,
in this sense they are controllable and under
the influence of management decision-
making.
- reductions in average cost per unit of
output as a result of increasing internal
efficiencies of the business.

• External - arise from the growth of the industry

and are independent of the size of the firm.
- the advantages of scale that benefit a
whole industry and not just an individual
business.
Internal Economies of Scale
• Purchasing economies – as businesses grow,
they increase the size of orders for raw materials
or components.

• Technical economies – as businesses grow

they are able to purchase the latest equipment
and incorporate new methods of production.

• Financial economies – as businesses grow they

will have access to a wider range of finance.
• Managerial economies – as businesses grow
they are able to employ specialist managers.

• Marketing economies – as businesses grow

each peso spent on advertising will have greater
benefit for the business.
EXTERNAL ECONOMIES OF
SCALE
• Supplier economies – a network of suppliers
may be attracted to an area where a particular
industry is growing.

• Educational economies – local colleges will set

up training schemes suited to the largest
employers’ needs, giving an available pool of
skilled labour.

• Financial economies – financial services can

improve, with banks and other financial
institutions providing services that may be
particularly geared towards a particular industry.
 ECONOMIES OF SCALE
Capital Land Labor Output TC AC
SCALE A 8 5 6 12
SCALE B 16 10 12 30

• Assume each unit of capital = P15.00, Land = P20.00 and

Labor = 12.00
• Calculate TC and then AC for the two different ‘scales’ (‘sizes’)
of production facility
 ECONOMIES OF SCALE
Capital Land Labor Output TC AC
SCALE A 8 5 6 12 292 24.33
SCALE B 16 10 12 30 584 19.47

• Doubling the scale of production (a rise of 100%) has led to an

increase in output of 150% - therefore cost of production PER
UNIT has fallen
• Overall ‘costs’ will rise but unit costs can fall
ECONOMIES OF SCALE
Unit
Cost

24.33

19.47

12 30 CRS Output
DISECONOMIES OF SCALE
• The factors that cause higher costs per unit of
output when the scale of an organisation
continues to increase – the causes of inefficiency
in large organisations.

REASONS ON DISECONOMIES OF SCALE

• Coordination issues
• Communication issues
• Motivation issues
• Overcrowding in industrial areas
• Increased price of resources
Question
• True or False? The concept of economies of
scale cannot be applied to the short run.
- True.

The concept of economies of scale, or returns to scale deals

with the effects of a proportional increase in all inputs. Since
in the short run some inputs are fixed, a proportional increase
in all inputs becomes impossible, therefore the idea of returns
to scale cannot be applied.
ECONOMIES OF SCOPE
• Economies of scope exist when the total cost of
producing Q1 and Q2 together is less than the
total cost of producing Q1 and Q2 separately.

• The extent of economies of scope can be

measured by estimating the percentage cost
reduction caused by joint production, as follows:
WHERE;
C(𝑄1 ) = represent the costs of producing outputs 𝑄1
C(𝑄2 ) = represent the costs of producing outputs 𝑄2
C(𝑄1 ) + C(𝑄2 ) = represent the costs of producing outputs 𝑄1
and 𝑄2 independently
C(𝑄1 + 𝑄2 ) = represent the costs of producing outputs 𝑄1
and 𝑄2 jointly.

• If economies of scope exist, the joint cost is less than the

sum of the individual costs, thus S is positive.

• The larger the value of S, the greater the economies of

scope; if S is zero there are no economies of scope.
MAIN CAUSES OF ECONOMIES
OF SCOPE
• The products may use common processing
facilities.

• There may be cost complementarity, especially

when there are joint products or by-products.
SAMPLE PROBLEM
• A firm produces both face cream and hand lotion. The cost
of separately producing 2,000 jars of face cream is P100.00
each or P200,000. If 4,000 bottles of hand lotion are
produced separately, the cost is P70.00 each or P280,000.
If 2,000 jars of face cream and 4,000 bottles of hand lotion
are produced together, the total cost is P300,000.

• To determine the economies of scope, we use the following

formula:
Economies of Scope:

200,000+280,000 −300,000
S= 300,000

180,000
S=
300,000

S = 0.6
DISECONOMIES OF SCOPE
• Diseconomies of Scope. Multi-product
production by a single firm that is less efficient
than having separate firms each specializing in
the production of a single product.