Economies of Scale &

Resource Mix

Economies of Scale &

Resource Mix

Unit costs formula

Average cost per unit is calculated using this formula:

Total production costs in period (£)

Total output in period (units)

Economies of scale

Arise when unit costs fall as

output increases

Arise when unit costs fall as

output increases

Economies of scale illustratedAverageCost perUnit (£)

Quantity of output

CostCurve

AC1

AC2

Q1 Q2

Unit costs are falling as output increases from Q1 to Q2

= economies of scale

Unit costs are falling as output increases from Q1 to Q2

= economies of scale

Unit costs start to rise as output rises above Q3

= diseconomies of scale

Unit costs start to rise as output rises above Q3

= diseconomies of scale

Q3

Minimum efficient scale

The output at which average unit costs of

production are at their minimum

The output at which average unit costs of

production are at their minimum

Internal v External Economies of Scale

Arise from the increased output of the business itself

Arise from the increased output of the business itself

InternalInternalOccur within an industry:

i.e. all competitors

benefit

Occur within an industry:

i.e. all competitors

benefit

ExternalExternal

Internal economies of scale

Buying economies

Buying in greater quantities usually results in a lower price (bulk-buying)

Technical Use of specialist equipment or processes to boost productivity

Marketing Spreading a fixed marketing spend over a larger range of products, markets and customers

Network Adding extra customers or users to a network that is already established (e.g. mobile phones)

Financial Larger firms benefit from access to more and cheaper finance

External economies of scale

• Arise from the industry as a whole – i.e. all competitors benefit

• Often associated with particular geographic areas– E.g. Creative & media in London

• Examples– Having many specialist suppliers close by– Access to research and development facilities– Pool of skilled labour to choose from

Diseconomies of scale

Factors which cause the average production cost per unit of a business to

increase above the efficient level

Factors which cause the average production cost per unit of a business to

increase above the efficient level

Examples of diseconomies of scale

• Poor communication• More difficult to control a larger,

more complex business• More frequent machinery &

employee breakdown if output & capacity utilisation is too high

• Loss of management focus

The resource mix

What is the optimal mix of labour and capital in a business?

Labour IntensiveLabour Intensive

Labour versus Capital intensity

Production relies on using labour

resources

Production relies on using labour

resources

Capital IntensiveCapital Intensive

Production relies on using capital

resources

Production relies on using capital

resources

Examples of labour / capital intensive industries

Labour intensive Capital intensive

Food processing Oil extraction & refining

Hotels & restaurants Car manufacturing

Fruit farming Web hosting

Hairdressing Intensive arable farming

Coal mining Transport infrastructure

Implications of intensity

Labour intensive Capital intensive

Labour costs higher than capital costs

Capital costs higher than labour costs

Costs are mainly variable= lower breakeven output

Costs are mainly fixed = higher breakeven output

Firms benefit from access to sources of low-cost labour

Firms benefit from access to low-cost, long-term financing

Benefits and drawbacks of capital intensive

Benefits Drawbacks

Greater opportunities for economies of scale

Significant investment

Potential for significantly better productivity

Potential for loss competitiveness due to obsolescence

Better quality & speed (depending on product)

May generate resistance to change from labour force

Lower labour costs

Benefits and drawbacks of labour intensive

Benefits Drawbacks

Unit costs may still be low in low-wage locations

Greater risk of problems with employee/employer relationship

Labour is a flexible resource – through multi-skilling and training

Potentially high costs of labour turnover (recruitment etc)

Labour at the heart of the production process – can help continuous improvement

Need for continuous investment in training

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