Thursday, 21 June 2018

Investopedia/Sean Ross: What are some examples of economies of scale?

What are some examples of economies of scale?
By Sean Ross

Economies of scale occur whenever a firm's marginal costs of production decrease. They can result from changes on a macroeconomic level, such as reduced borrowing costs or new infrastructure, or from improvements on a business-specific level. This means a firm can sometimes realize economies of scale, or diseconomies of scale, based on variables outside of its control.

Nineteenth-century economist Alfred Marshall was the first to distinguish between internal economies of scale, which are controlled by the firm, and external economies of scale, which impact the industry as a whole. Marshall argued that external economies of scale lead to positive externalities and greatly contribute to economic growth. The invention of the Internet has created external economies of scale for businesses of all types by reducing the cost and time required to gather information; communicate with consumers and partners; and speed up operations.

Internal economies of scale can arise from many different sources. Economic theory suggests economies of scale arise as firms begin to specialize in their operations. This specialization can happen in the production process, the administrative process or the distribution process. For example, in a very micro sense, employees who use a keyboard can increase their marginal productivity by becoming better typists, which reduces the cost, or time, of each additional word typed.

Technical economies of scale can be achieved by improving the capital equipment and production processes that a firm uses. When Henry Ford introduced the assembly line to his automobile manufacturing plant, he significantly improved his company's economy of scale. By the time other businesses began adopting his more efficient production process, the assembly line had moved from being an internal economy of scale to an external one.

Some large, reputable firms can realize financial internal economies of scale by borrowing funds at lower interest rates than their competitors. Lower rates reduce the interest costs of capital expansion. This allows additional units to be produced with fewer input costs. On a more aggregate scale, financial external economies of scale can occur whenever the market rate of interest falls and borrowing costs decline across the entire economy.

Globalization has led large businesses to realize greater economies of scale by allowing them to pursue cheaper resources around the world. It may be cheaper, for instance, to employ labor in a workforce-rich developing country than in the United States. These scale economies do not just extend to labor; any input resource obtained at a lower cost can help reduce marginal costs, assuming the cost of finding, transporting or incorporating does not wash out any gains. Theoretically, globalization allows the productivity of the world to be maximized by allowing increased specialization, division of labor and economies of scale commensurate with the combined resources of the entire globe.

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