File Name: difference between economies and diseconomies of scale .zip
Diseconomies vs Economies of Scale. Diseconomies of Scale is an economic term that defines the trend for average costs to increase alongside output. At a specific point in production, the process starts to become less efficient.
In other words, it starts to cost more to produce an additional unit of output. In economic jargon, diseconomies of scale occur when average unit costs start to increase. For example, the graph below illustrates that at a point Q1, average costs start to increase. In turn, each employee serves 20 customers. The coffee shop sees an increase in demand, so there are now customers per hour.
The store responds by hiring two new staff members to serve the extra 40 customers. This subsequently means that they are only able to serve 30 additional customers. The new workers are only able to serve 30 customers, or 15 each — much lower than the 20 being serviced before. Diseconomies of scale can be split into two categories: internal and external. Internal diseconomies are factors that are directly controlled by the firm.
For instance, the organizational structure and process management can become too complex if it is not controlled efficiently. This can lead to miscommunication and duplication of work, and therefore, diseconomies of scale.
For example, the local infrastructure may mean employees get stuck in traffic or suffer from train delays. This may result in staff being late, stressed, and therefore, unproductive. Technical diseconomies occur during the production process. This may be on the factory line, behind the counter at a cafe, or a worker at the office.
In other words, it costs the firm more to produce more goods or services. For instance, a firm may overcrowd its offices or factories beyond reasonable capacity. We can also think of technical diseconomies as the method of production. So, how the product is made. Technical diseconomies of scale can happen when a firm grows quicker than it is able to adapt.
These generally occur when a firm invests heavily in new capacity. For instance, existing stores may be efficient, which encourages firms to invest in new stores. However, those stores are not necessarily as efficient as the first. Overcrowding When expanding, the firm may increase production beyond reasonable capacity. This may include putting too many barristers behind the bar at the coffee shop. Scalability Although a store may be highly efficient in one location, the firm may expand into another that is not.
In turn, the average cost of production increases. Organizational diseconomies occur when a larger workforce becomes more difficult to manage.
For example, Mr. Jones owns several bakeries. He hires 5 employees in each of his 10 stores so he now has an additional 50 employees. On his own, it is incredibly difficult to manage and plan the schedules, wages, and other factors for these new workers. In turn, he may have to hire additional managers, accountants, and lawyers, thereby adding to costs.
Simply put, they are inefficiencies that arise with regards to the management of people. Examples include inefficient communication, lack of motivation, greater sick days, lack of responsibility, or ownership of tasks. Communication Organisational diseconomies occur when the firm expands. In turn, new departments open alongside new employees.
For all involved, it can create a minefield. To get something done, an employee may need to go through various departments to find assistance. The big successful firms tend to resolve such issues. Although some inefficiencies may still occur. Demotivation As the firm grows bigger, there are also psychological issues that can arise. For instance, being one of the , employees can create a feeling of insignificance.
Furthermore, managers may easily overlook any individual successes. As a result, employees can feel demotivated, thereby under-performing and creating inefficiencies.
Employee Health As stated previously, employees can feel like just another cog in the wheel of a big firm. However, big firms can also create a feeling of isolation for many. When there is a set and standard procedure to follow, it can feel rather robotic. This sense of isolation and insignificance not only affects motivation, but also health. In turn, employees may take off more sick days, become less productive, and also be less innovative.
Sometimes, big firms can end up paying more than it would as a small company. If we think of Google, Apple, or Microsoft, they all have significant levels of cash flow.
As a result, it is inevitable that such firms end up overpaying for various goods. One example includes Apples purchase of Beats back in Naturally, if a big firm wants an asset, good, or service, it is willing and able to do so despite the price.
This is because it has both the desire and resources — something a smaller firm may not be able to. Higher Costs As firms become increasingly willing to spend more, they are more likely to overpay for goods and services.
In turn, this will end up impacting their bottom line. Greater Waste As a firm gets bigger, there becomes a disconnect between management and the average employee. Consequently, the needs of the worker are often forgone and overlooked. Management may buy resources employees do not need or want. Deadlock Some large firms recognise that there are levels of reckless spending.
As a result, purchasing decisions may go through round after round of approval, eventually getting blocked at the last stage. In turn, the firm may not actually progress. Strong and competitive markets are key to keeping businesses efficient.
When there is little competition, there is less pressure to reduce costs. For instance, a firm that owns a monopoly has little incentive to reduce costs and increase efficiencies as there is no competition that may put it out of business.
At the same time, customers do not have an alternative so are forced to pay for the price. As a result, non-competitive markets tend to have higher costs than under competitive conditions. Competition can be worn down over time as a firm grows bigger and bigger. For instance, Amazon has grown at a rapid pace and now has a strong position in the eCommerce market. Although it does not have a monopoly, it has little in the way of competition.
In turn, such large companies may suffer from inefficiencies if management do not keep on top of the numerous issues that may result. When there is little competition, there is less pressure on management to do so. In addition, high profits with large costs, acts as a signal to potential competitors.
Higher Costs : Companies that have significant market share usually have thousands of employees. As a result of its strong positioning, it may find management does not have the same incentives to implement universal efficiencies within the firm.
As a firm grows bigger, it may look to buy new factories or real estate. In turn, it will require new sources of funding. If these are no organically raised, they will come from external sources such as banks or other financial instruments. As a result, the firm will have to repay interest. This creates an additional cost that smaller firms do not always have.
As costs of financing increases, so too do the costs of managing financial records. More accountants and legal teams may be required. In turn, the final cost of production can increase if productivity does not grow over and above these costs. Expanded Workforce : Borrowing more assets requires more employees to oversee the finances, as well as to manage those resources. As the firm needs to hire more workers, it may also need to borrow more.
High Levels of Interest : When a firm uses external finance to grow inorganically, it can become increasingly expensive to continue. The more a firm borrows, the riskier it becomes for investors. In turn, lenders account for the risk with higher interest rates. External diseconomies refer to costs that increase due to factors outside of the company but impact the whole industry. In other words, as the industry grows, diseconomies impact the firm as well as the wider industry.
As an industry grows larger, it can create additional costs to the local or national population. For example, several factories may open in close proximity to each other in order to benefit from efficiencies. This may come from knowledge efficiencies, supplier efficiencies, or other such efficiencies.
These occur when mass producing a good results in lower average cost. Economies of scale occur within an firm internal or within an industry external. Internal Economies of Scale - As a business grows in scale, its costs will fall due to internal economies of scale. An ability to produce units of output more cheaply. External Economies of Scale - Are those shared by a number of businesses in the same industry in a particular area. Occur when firms become too large or inefficient.
AO2 You need to be able to: Demonstrate application and analysis of knowledge and understanding Command Terms: These terms require students to use their knowledge and skills to break down ideas into simpler parts and to see how the parts relate: Analyse, Apply, Comment, Demonstrate, Distinguish, Explain, Interpret, Sugges. Economies of scale are when the cost per unit of production Average cost decreases because the output sales increases. Diseconomies of scale are when the cost per unit of production Average cost increases because the output sales increases. Growth brings both advantages and disadvantages to a business. These interact, and depending on the nature of the business and the way it is managed, decide the optimum or most efficient size for the business.
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