3 3.3 Economies and Diseconomies of Scale Edexcel Reference Library Economics

This lack of motivation among workers will eventually result in higher unit cost. Lower employee motivation can also lead to higher labour turnover in firms. The external diseconomies of scale arise when long run average unit cost is increased, not due to any of the firm’s actions, but because of growth of industry. Otherwise known as HRM, human resource management involves improving recruitment, promotion, training, retention, support, and so forth of employees.

• ‘X’ inefficiency means that average costs are higher than what would be experienced by firms in more competitive markets.
• In this market, a buyer would only be concerned about prices, not quality or different features.
• For instance, manufacturing firms may face supply chain challenges if suppliers encounter capacity or logistical issues.
• Larger organizations require more elaborate management structures, which can slow down decision-making and create communication barriers between departments.

This disruption has a higher chance of affecting large organizationscitation needed – especially when there are only a few large suppliers. Smaller organizations with robust, local supply networks can manage supply chain shocks because any localized shock has a smaller effect on the overall ecosystem. Problems that affect the whole industry often happen because there are just too many firms in the same market. Growth of the industry may lead to a shortage of labour with the appropriate skills. Maintaining an efficient, lucrative business involves finding the optimal scale of a firm—not too small or too large to maximize efficiency and profit (see the graph below for a visual explanation of this). An external economy (positive externality) occurs when one person or business confers benefits on others for which it is not immediately feasible to charge.

The economic impact of airport hubs – lesson resource

When a firm grows too quickly, it might be difficult to continually scale up production in a way that is feasible and functional. At a certain point, the firm starts to become less efficient and the cost of production increases. It occurs when a company reaches a certain size where expansion makes the cost of external diseconomies of scale production increase. Factors include organizational diseconomies, technical, infrastructural, and financial diseconomies.

What Are Diseconomies of Scale? Causes, Types, and Examples

Greater WasteAs a firm gets bigger, there becomes a disconnect between management and the average employee. The coffee shop sees an increase in demand, so there are now 140 customers per hour. The store responds by hiring two new staff members to serve the extra 40 customers. However, the store hasn’t increased in size, so the new staff starts getting in everybody’s way and making orders twice. This subsequently means that they are only able to serve 30 additional customers. Larger firms have a reputation to uphold and as a result may place more restrictions on employees, limiting their efficiency.

🖿  BUSINESS EDUCATION:

At large firms, CEOs must delegate a fair amount of their decision-making to managers. This can lead to greater inefficiency because of the principal-agent problem. Managers may not be able or motivated to make decisions in line with the goals of the CEO. For instance, store managers may favor certain employees based on personal ties rather than their productivity, which adds inefficiencies to the system. At a small firm, the CEO has more direct oversight, making this much less of a concern.

Effects of Limited Natural Resources

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. As a result, such factories may create additional costs in the form of pollution to its local surroundings. As costs of financing increases, so too do the costs of managing financial records. In turn, the final cost of production can increase if productivity does not grow over and above these costs.

What is Production in Economics? Concept, Factor, Importance

Conducting resource audits and using balanced scorecards can ensure that all areas are adequately supported and aligned with strategic objectives. Since workers have greater choice from a large number of employers being located in the local area, it may take much longer for companies to sign new employees. Many of the job seekers may delay signing their labor contracts trying to negotiate a better deal putting one company to bet against the other.

It is able to draw more output per unit of input, leading to low average total costs. Any industry-wide effects that make it more difficult or more costly to perform business operations is called an external diseconomy of scale. DemotivationAs the firm grows bigger, there are also psychological issues that can arise. For instance, being one of the 500,000 employees can create a feeling of insignificance. As a result, employees can feel demotivated, thereby under-performing and creating inefficiencies. Explore how diseconomies of scale impact business efficiency and cost structures, highlighting internal and external factors.

Technical diseconomies of scale involve physical limits on handling and combining inputs and goods in process. These can include overcrowding and mismatches between the feasible scale or speed of different inputs and processes. External economies of scale refer to the economies in production that a firm achieves due to the growth of the overall industry in which the firm operates. These could range from labour, to land, to physical resources, such as coal. 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.

Increased ComplexityAs a company grows, its operations become more complex, requiring more elaborate management structures and coordination among departments. This added complexity can result in slower decision-making, communication breakdowns, and operational inefficiencies, which increase costs. The firm normally experiences the economies of scale first, where unit cost decreases when the level of output increases. There will be an optimum minimum average unit cost at a certain level of output.

• There are two types of phenomena that owe their names to external economies and external diseconomies.
• In other words, as the industry grows, diseconomies impact the firm as well as the wider industry.
• Employee Motivation and ProductivityAs a company expands, it may struggle to maintain employee motivation and a cohesive corporate culture.
• This will increase labor costs without necessarily increasing output anyhow, thereby raising average costs of production.

Solutions to the diseconomies of scale for large firms may involve splitting the company into smaller organisations. This can either happen by default when the company is in financial difficulties, sells off its profitable divisions and shuts down the rest; or can happen proactively, if the management is willing. Market SaturationExpansion can lead to market saturation, where the supply of products or services exceeds demand. This can force the company to invest more in marketing and promotional activities to maintain market share, driving up costs. There are two types of phenomena that owe their names to external economies and external diseconomies.

Examples include inefficient communication, lack of motivation, greater sick days, lack of responsibility, or ownership of tasks. Note that all these changes will likely result in a substantial reduction in corporate headquarters staff and other support staff. For this reason, many businesses delay such a reorganization until it is too late to be effective.

Investing in employee training and defining job roles can streamline operations, improve productivity, and foster a culture of adaptability. Too many businesses wishing to locate their offices or factories in a certain area can cause available rental inventory to become scarcer, thereby increasing rent prices. Higher rent adds to the Fixed Costs of all businesses in the area without any corresponding increase in output causing unit costs to rise.

In turn, prices go up to make it more profitable and worthwhile to extract resources that are more difficult to reach. For instance, oil fields in the middle of the ocean can be a logistic and financial nightmare. 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.

For companies, understanding these dynamics is crucial for strategic planning, location decisions, and managing growth to avoid diminishing returns on investment. As companies grow, they may drive up the demand for raw materials or components, leading suppliers to increase prices. Larger firms often face higher costs for inputs as suppliers leverage their pricing power due to the increased demand from multiple large customers. This situation can erode the cost advantages of scaling up, as the cost of acquiring essential resources rises, impacting the overall profitability and operational efficiency of the business.

As costs increase due to factors outside a firm’s control, it may become more challenging to maintain profit margins without raising prices or compromising on quality. This situation can make a firm less competitive compared to others in regions where such external pressures are not as intense. Therefore, recognizing and addressing these externalities is crucial for maintaining a competitive edge. Sometimes, diseconomies of scale happen within an organization when one division within a company cannot produce the same quantity of output as another division. For example, imagine a product is made up of two components, gadget A and gadget B, each produced by different divisions. If gadget B is produced at a slower rate than gadget A, the company would need to slow the production rate of gadget A or add resources to increase production of gadget B, increasing the product’s per-unit cost.