What role can economies of scale play in increasing the gains from trade?
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Ever wondered why a larger business can charge so much less than a smaller business for a similar product? It’s all about economies of scale – cost reductions that can occur when businesses increase production. Find out everything you need to know about the advantages and disadvantages of economies of scale and see why maximising business growth is so important for start-ups and early-stage businesses.What are economies of scale?Economies of scale are cost advantages that can occur when a company increases their scale of production and becomes more efficient, resulting in a decreased cost-per-unit. This is because the cost of production (including fixed and variable costs) is spread over more units of production. Economies of scale provide larger companies with a competitive advantage over smaller ones, because the larger the business, the lower its per-unit costs. Example of economies of scaleA common example of economies of scale in action is seen when looking at large supermarket chains versus independent grocers. With the larger chains having more cash in the bank and a greater number of customers, they are able to purchase a huge quantity of groceries from suppliers, resulting in a lower cost per unit, compared to the independent stores. This is why it's cheaper to do your weekly shop at a big chain rather than a small business. What are the different types of economies of scale?There are two main types of economies of scale – external and internal. External economies of scaleExternal economies of scale are dependent on external factors. Anything that enables a company to cut down on costs can be considered an external economy of scale, including tax reductions, government subsidies, an improved transportation network, or a highly skilled labour pool. Internal economies of scaleInternal economies of scale are controlled by the company. They can occur any time a company cuts costs, from buying in bulk and investing in state-of-the-art machinery to accessing extra financial capital and hiring a specialised workforce. Technical economies of scaleTechnical economies of scale are a type of internal economy of scale. They are economies of scale achieved via technology. That is, larger businesses more readily have the capital to invest in newer and better technology, which can bring them cost advantages smaller businesses are otherwise unable to achieve. Purchasing economies of scalePurchasing economies of scale, also called buying economies of scale, are a type of internal economy of scale. They are economies of scale achieved via buying in bulk. That is, larger businesses more readily have the cash and output to warrant buying materials in much larger quantities, which can bring them per-unit cost advantages smaller businesses are otherwise unable to achieve. Financial economies of scaleFinancial economies of scale are a type of internal economy of scale. They are economies of scale enable more favourable rates of borrowing. That is, larger businesses are seen by lenders as more reliable or worthy of credit due to their size, whereas smaller businesses will tend to pay higher rates of interest. Advantages of economies of scaleThe benefits of economies of scale to industries and businesses are wide-ranging, but generally speaking, it enables large corporations to reduce their costs, pass the savings onto the consumer, and gain an advantage over the competition. So, what are the advantages of economies of scale?
Of course, there are also plenty of advantages of economies of scale for consumers, as lower unit costs often feed through to reduced prices. What are the advantages of economies of scale for consumers?
Disadvantages of economies of scale (Diseconomies of scale)When a business becomes too large, its unit costs may begin to rise. This is referred to as a diseconomy of scale, and it’s a major drawback that growing businesses need to pay attention to. Diseconomies of scale can be caused by a number of different factors, including:
In addition, the benefits of internal economies of scale for consumers may not be as impressive as they appear. For a start, economies of scale may not always result in lower prices, as dominant firms may simply form a monopoly and enforce higher prices. It’s also worth remembering that the environmental consequences of mass production can be significant, from pollution to e-waste. Making economies of scale work for youWhile there are some drawbacks associated with economies of scale, these can be averted through a greater focus on management and communication. And while the benefits of economies of scale can be leveraged more effectively by large companies, even start-ups and small businesses can take advantage. Why are economies of scale important for trade purposes?Economies of scale are important because they can help provide businesses with a competitive advantage in their industry. Companies will therefore try to realize economies of scale wherever possible, just as investors will try to identify economies of scale when selecting investments.
How does economies of scale increase profits?Economies of Scale Definition
Economies of scale are cost savings that a company (and, by default, its customers) can reap as a result of efficient production processes. Generally, these cost savings are achieved because the average cost of producing something falls as the volume being produced increases.
Is economies of scale an advantage of trade?Increased profits – Economies of scale lead to increased profits, generating a higher return on capital investment and providing businesses with the platform to grow. Larger business scale – As a business grows in size, it solidifies and becomes less vulnerable to external threats, such as hostile takeover bids.
What is economies of scale and its gain from trade especially in the international market?Economies of scale refer to the cost advantage experienced by a firm when it increases its level of output. The advantage arises due to the inverse relationship between the per-unit fixed cost and the quantity produced. The greater the quantity of output produced, the lower the per-unit fixed cost.
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