When Do Firms Experience Economies of Scale?

A firm experiences economies of scale when increaing output least to a reduction in long run average costs.  As firms grow they also experience economies of scale.

The word economies refers to efficienceies and cost reductions, the word scale refers to an increase in size e.g. scaling up.
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Diagram showing the reduction in costs due to increased output.

The diagram shows the long run average cost curve as a downward sloping curve between Q1 and Q2.

As the firm increases output to Q2 the long run average costs fall from C1 to C2.

The diagram shows that as the firm increases in size and output it is able to become more efficient.

Types of Economy of Scale

1. Purchasing - When average costs fall as products are bought in bulk.  increased output 
2. ​Technical - When average costs fall due to larger machinery with increased output.  e.g. cost savings in machinery due to mass production
3. Marketing - When average costs fall due as marketing campaigns increase in size.  National marketing campaigns are likely to be more cost effective in than local campaigns.
4. Financial - Larger firms can take larger loans at lower interest rates. Smaller firms with fewer colateral assets taking out smaller loans are likely to be charged much higher interest rates than larger firms.
5. Managerial - When average costs fall due to managers being able to manage a larger number of employees.  A marketing manager in a small firm may oversee 3 or 4 marketers. In a larger firm one manager may oversee 15 or 20 marketers.  In the larger firm the cost of the manager's salary is much lower per sale.
6. External - When average costs dall due to the increasing size of the industry as a whole.  As an industry grows the government may introduce and pay for national training programs to produce workers where previously the firms had to train their own workers.

What are Diseconomies of Scale?

In the diagram above, after Q2 the LRATC begins to rise.  This is known as diseconomies of scale - average costs rising as output increases. There are a number of reasons that costs may rise such as managers losing control of employees as they need to manage a higher number of workers or firms having to pay overtime to workers in order to increase output.