Economies of Scale

Definition:

Decreasing the long-run average and marginal costs that come from an increase in the size of a factory or plant. Economies of scale can be from the inner workings of an organization. This could include the lower cost from adding technology and better organization.

Details on Economies of Scale

In simpler terms economies of scale is a decrease in your costs thanks to being bigger.

Take, for example, two car manufacturers. The first has a very small shop, with five employees. He only sells five cars a year so he can only invest 1,000$ each year to hire employees, robots and other ways of building his cars faster. The employees will have to be able to do a lot of different things. They also won’t be able to buy robotics. Another big problem is that they won’t have enough room to work on cars all at the same time, they may get in each others way or have to wait for the person before him to finish.

On the other hand, the second car producer sell thousands of cars and can invest millions each year. Unlike the small car producer he can have specialized workers do a task one after the other and very quickly. He can also buy specialized robots that can do the job much faster than any human. He can do this because his scale or size is bigger, he cant afford to invest in bigger and better machines because he already makes so much money producing lots of cars.

One of the greatest examples of economies of scale is Ford [htmwquote]F[/htmwquote], he was a pioneer in this and was able to achieve great success by having people do one thing really well.

Bigger is not always better

There is a point in economies of scale, however, where things will actually get less efficient and more expensive. An example of this is hiring so many workers that they just step over each other, or have too little to do. That’s why companies strive to keep themselves in a happy middle and have the lowest costs possible.