Why economies of scale?

Question

Why economies of scale?

why do economies of scale happen? like bulk-buying. why would it be cheaper if you order 1000 than 500+500? who sets these rules. is it the supplier who makes the deal with you that they will offer a lower cost per unit if you order more? please explain...exam soon. thanks!

Answer 1

It's very much like driving a car ( I hope your old enough to drive) . . . the magic number for most cars for maximum fuel efficiency hovers around 45 miles per hour . . . the further away you get from that number the more inefficient the car becomes . . . so if you to calculate how much it will cost you to drive from point A to point B . . . 30 miles per hour will cost more than 45 miles per hour . . . and 75 miles per hour will cost more than 45 miles per hour . . . because the vehicle was produced for maximum efficiency at 45 miles per hour.  

Insert Maximum Efficiency of Production for economies of scale . . . they are for the most part interchangable.

Answer 2

Economies of scale allows to benefit from specialization, in your case to transport 1000 you need one cas and one load/unload operation but in 500+500 case you will need two cars and two load/unload operations, double papers, two drivers, etc, It concerns both sides of a deal, supplier will need to make two operations registering cargo but customer will need to register cargo in also two times.

Answer 3

It's useful to think about the economy of scale beginning on the production side, and then follow it along to pricing etc.

When you produce a product, you have a combination of fixed and variable costs.  Often the fixed costs per unit go lower and lower as you increase the volume of your production run.  At least for a while.   Eventually, going to a huge scale can begin to increase costs because of scarcity or difficulty in finding sources of materials, getting permission to build large enough plant and equipment, risks from variations in the market for your products, etc.

But lets focus on when you do see these economies.

You build a factory, buy machines, hire workers, buy materials and go to work making products 5 days a week, 8 hours a day.  Life is good.  The products sell, and you make some money.

Then you find out that there are more people in your area who would like to work for you, since everything is going so smoothly, and your customers would like to buy more of your products too.   So you add a second shift.   You pay a little more in wages, since not as many people want to work second shift, but its not much more, and you save a ton on not having to buy a factory or more machines, since those were sitting idle anyway.  You pay more for maintenance on that stuff since you use it more, but nothing like it would have cost to build a second factory and fill it with equipment again.

So you are achieving economies of scale.  Your management team grows a bit, but it doesn't double in size, and you actually save a little money on materials, since you are buying more of them and have a little more bargaining power with your suppliers.

Why do you get more bargaining power when you buy more?  Because the transactions costs for your supplier, per unit sold, are lower.  They don't have to go out and find another customer for the extra units you are buying, they don't have to send out new invoices, service new accounts, etc.  Just a little more work to double the sale.   So your supplier is achieving an economy of scale with you as well.

Economies of scale are all over the place, but the factory example is the least complicated, in terms of a cyclical effect.

Answer 4

Economies of scale are when average costs are decreasing as output increases.

e.g. If it cost $50 a day to hire a worker, but they produced $100 of output each day, this means that the revenue from output will eventually become a lot greater than the cost of hiring the workers if the amount of workers keep increasing.