Economies & Diseconomies of Scale

Exam code: 7115

Written by: Ashika|Reviewed by: Caroline Carroll|Updated 2 July 2026

As a business grows, it is able to increases its scale of output which generates efficiencies that lower its average costs (AC) of production
- These efficiencies are called economies of scale
- Economies of scale help large firms lower their costs of production beyond what small firms are able to achieve
Economies of scale can result in lower average (or unit) costs, not lower total costs
- The total costs will increase, but at a decreasing rate per unit

With relatively low levels of output, the firm's average costs are high
As the firm increases its output, it begins to benefit from economies of scale, which lower the average cost per unit
The business will reach a level of output at which costs are minimised
- This point is found at the dotted line in the image above

Economies of scale are generated by several internal factors, some of which the business has control over

Type of economy of scale	Explanation
Purchasing economy	Occurs when large firms buy raw materials in greater volumes and receive a bulk purchase discount This lowers the average cost and provides a competitive advantage over smaller businesses
Managerial economy	Occurs when large firms can employ specialist managers who are more efficient at certain tasks This efficiency lowers the average cost Managers in small firms often have to fulfil multiple roles and are less specialised
Marketing economy	Occurs when large firms spread the cost of advertising over a large number of sales, reducing average costs They can also reuse marketing materials in different geographic regions, which further lowers the average costs
Financial economy	Banks are more willing to lend to large businesses, as they present less of a risk than small businesses They are charged a lower rate of interest on borrowing, reducing average costs
Technical economy	Occurs as a firm is able to use its machinery at a higher level of capacity due to increased output This spreads the cost of the machinery over more units and lowers the average cost

A diseconomy of scale occurs when an increase in the scale of output results in a higher cost per unit
As a firm continues increasing its scale of output, it will reach a point where its average costs (AC) will start to increase

At some level of output, a firm will not be able to reduce costs any further. This point is called productive efficiency
Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale
This indicates that there is an optimal level of output that exists when the state of technology and capital (machinery) is fixed

Diseconomies of scale highlight that it is possible for a business to become so large that it becomes less and less efficient
A business experiencing diseconomies of scale may reconsider its organisational structure to improve communication and coordination problems
- Many very large businesses often break themselves up into autonomous smaller units, which can communicate more effectively

Type of diseconomy of scale	Explanation
Poor communication	As a business increases in size, more managers and employees will join the business Communication becomes slower and mistakes may be made, leading to worsening efficiency
Weak coordination	Time-consuming decision-making may make it harder to coordinate workers and physical resources The chain of command is likely to lengthen, limiting interaction with employees
Lack of commitment from employees	As the business grows workers may feel less valued as their interaction with management is limited Workers may become demotivated, leading to a fall in output which can increase average costs

Economies of scale