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Economies of Scale

Economies of scale is the cost advantages businesses gain as their production output increases. In other words, as a company produces more units of a product or provides more services, its average cost per unit decreases. This phenomenon occurs because the fixed costs are spread over a larger quantity of output, leading to higher efficiency and lower per-unit costs.

What You Need To Know

Internal economies of scale arise from factors within the company's control. As production increases, a company can benefit from cost-saving advantages such as better utilization of production facilities, more efficient use of resources, improved specialization of labor, and bulk purchasing discounts on raw materials. Internal economies of scale help a company improve its competitiveness and profitability.

External economies of scale result from external factors outside the company's control. They arise when multiple firms in the same industry or geographic area benefit from common infrastructure, shared services, or a skilled labor pool. For example, companies located in an industrial park may benefit from shared utilities or transportation facilities, leading to cost savings for all the firms operating in the area.

Economies of scale are essential for businesses looking to maximize their efficiency and reduce production costs. By achieving economies of scale, companies can improve their profit margins, offer competitive prices to consumers, and potentially enter new markets with greater cost advantages.

Note that economies of scale have limits. Eventually, as production continues to increase, diminishing returns may set in, and the cost-saving benefits of economies of scale may start to diminish. Additionally, certain industries or products may not be able to take full advantage of economies of scale due to specific constraints or complexities associated with their production processes.