Economies of scale arise when the cost per unit falls as output increases. Economies of scale are the main advantage of increasing the scale of production and becoming ‘big’.
Why are economies of scale important?
- Firstly, because a large business can pass on lower costs to customers through lower prices and increase its share of a market. This poses a threat to smaller businesses that can be “undercut” by the competition
- Secondly, a business could choose to maintain its current price for its product and accept higher profit margins. For example, a furniture-maker which could produce 1,000 cabinets at £250 each might expand and be able to produce 2,000 cabinets at £200 each. The total production cost will have risen to £400,000 from £250,000, but the cost per unit has fallen from £250 to £200. Assuming the business sells the cabinets for £350 each, the profit margin per cabinet rises from £100 to £150.
Why are economies of scale important?
- Firstly, because a large business can pass on lower costs to customers through lower prices and increase its share of a market. This poses a threat to smaller businesses that can be “undercut” by the competition
- Secondly, a business could choose to maintain its current price for its product and accept higher profit margins. For example, a furniture-maker which could produce 1,000 cabinets at £250 each might expand and be able to produce 2,000 cabinets at £200 each. The total production cost will have risen to £400,000 from £250,000, but the cost per unit has fallen from £250 to £200. Assuming the business sells the cabinets for £350 each, the profit margin per cabinet rises from £100 to £150.
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