Students should be able to: Identify economies and diseconomies of scale. Students must be able to distinguish and give examples of internal and external economies and diseconomies of scale.

1. Economies and
Diseconomies of Scale and
Market Competition
Economies and Diseconomies of Scale

2. Economies & Diseconomies of Scale,
Economies of Scope, Natural Monopolies
A2 Microeconomics
Students should be able to:
• Identify economies and diseconomies of scale.
• Distinguish and give examples of internal and external
economies and diseconomies of scale
• Understand the significance of economies of scale for the
structure of market competition

3. Key Concepts – Long Run Costs
Constant returns to scale
When long run AC remains constant as
output increases because output is rising
in proportion to inputs used
Diseconomies of scale
(DEoS)
A business may expand beyond the
optimal size and experience rising Long
Run Average Cost (LRAC)
Economies of scope
Where it is cheaper in the long run to
supply a wider range of products
External economies of
scale (EEoS)
When expansion of an industry leads to
the growth of ancillary services causing a
downward sloping industry supply curve
Minimum efficient scale
(MES)
Where internal economies of scale have
been fully exploited. It is the lowest point
on the long run average cost curve.

4. Economies of Scale in the Long Run
• In the long run all production costs are variable
• In the long run, the scale of production can change (i.e.
there are no fixed factor inputs)
• Economies of scale are the unit cost advantages from
expanding the scale of production in the long run.
• These lower unit costs represent an improvement in long
run productive efficiency and they can give a business a
significant competitive advantage in a market.
• They can also lead to lower prices for consumers and
higher profits (i.e. producer surplus)
• If long run average total cost curve (LRAC) is declining,
then internal economies of scale are being exploited

5. Technical economies
i.e. containerization
Specialist capital
machinery /
technology
Purchasing
economies
(monopsony power)
Large scale
application of the
division of labour
Using specialist
managers
throughout the
supply chain
Financial economies
e.g. lower interest
rates on loans
Risk-bearing
economies from
diversification
Network economies –
which helps to lower
marketing costs
Google and Apple’s RevenueInternal Economies of Scale (IEoS)

6. Economies of Scale: Super Cruisers
5,400
4,200
4,200
4,180
4,180
4,100
4,000
3,969
3,700
3,611
3,600
3,364
3,250
3,250
2,660
0 1000 2000 3000 4000 5000 6000
Royal Caribbean Oasis Class 3
Norwegian Escape
Norwegian Bliss (Breakaway)
Royal Caribbean Quantum Class
Royal Caribbean Anthem of the Seas
Royal Caribbean Quantum of the Seas
Carnival Vista
Norwegian Gateway
Costa Cruise Diadema
P&O Brittania
Regal Princesse
Star Cruises
Aida Prima
AIDA
Holland America Pinnacle Class
Capacity

7. Containerization and the Size of Ports
35.28
33.9
24.03
22.3
19.45
18.65
16.62
16.16
15.24
14.05
12.3
10.94
10.59
10.59
0 5 10 15 20 25 30 35 40
Shanghai
Singapore
Shenzhen
Hong Kong
Ningbo
Busan
Qingdao
Guangzhou
Dubai
Tianjin
Rotterdam
Port Kelang
Kaohsiung
Dalian
Throughput in million TEUs
What are TEUs?
TEUs are twenty-foot
equivalent units (TEUs),
a standard-size
container

8. Economies of Scale in Computer Games
9.89
7.73
7.25
3.92
3.32
3.25
2.05
1.7
1.46
1.26
0 2 4 6 8 10 12
Sony Computer Entertainment (Tokyo/ Japan)
Tencent (Shenzen/ China)
Microsoft (Redmond/ USA)
Nintendo Company Ltd. (Kyoto/ Japan)
Activision Blizzard Inc. (Santa Monica/ USA)
Electronic Arts (Redwood City/ USA)
Namco Bandai Games (Tokyo/ Japan)
King Digital Entertainment plc (Dublin/ Irland)
Ubisoft Entertainment (Montreuil sous Bois/…
GungHo Online Entertainment (Tokio/ Japan)
Revenue in billion euros
Revenue of the largest computer and video game
publishers worldwide in 2015 (in billion euros)

9. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2
Economies of
scale cause
AC to fall
Economies of scale arise from increasing returns to scale in the long run
Google and Apple’s RevenueInternal Economies of Scale

10. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2 Q3
Economies of
scale cause
AC to fall
Lowest point on LRAC
is the output of
productive efficiency
Economies of scale arise from increasing returns to scale in the long run
Google and Apple’s RevenueInternal Economies of Scale

11. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2 Q3
Economies of
scale cause
AC to fall
Lowest point on LRAC
is the output of
productive efficiency
Economies of scale arise from increasing returns to scale in the long run
Rising LRAC – means
diseconomies of scale
Google and Apple’s RevenueInternal Economies of Scale

12. Output
Cost
per unit
LRAC
Economies of
scale
(increasing
returns)
Constant
returns to scale
(LRAC remains
the same)
Diseconomies
of scale i.e.
decreasing
returns
The minimum efficient scale (MES) is the scale of output
where internal economies of scale have been fully exploited
Google and Apple’s RevenueMinimum Efficient Scale (MES)

13. Cost & Price
Output (Q)
Low MES, limited internal scale
economies, contestable market
LRAC
Q1
Minimum
efficient
scale (MES)
Scope for many firms to
reach the MES
Google and Apple’s RevenueMES and Different Shaped LRAC Curves

14. Cost & Price
Output (Q)
Low MES, limited internal scale
economies, contestable market
LRAC
Q1 Output (Q)
High MES, falling LRAC, high
barriers to contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
A Natural Monopoly
Minimum
efficient
scale (MES)
Scope for many firms to
reach the MES
Q1 Q2 Q3 Q4
Google and Apple’s RevenueMES and Different Shaped LRAC Curves

15. Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
A Natural Monopoly
Q1 Q2 Q3 Q4
London Underground
Water & Sewerage
Networks
Google and Apple’s RevenueFalling LRAC for a Natural Monopoly

16. Google and Apple’s RevenueNatural Monopoly and Digital Platforms
Web Search Messaging E-Commerce
Taxi apps Streaming
services
Sharing
economy
• We are seeing the
rapid rise of
digital platform
businesses –
some of whom
may morph from
being a business
to being a market
• Are they natural
monopolies?
• Platform
businesses bring
consumers and
suppliers together

17. Output (Q)
Cost & Price
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
With economies of scale, the
profit maximising price and
output changes to P2, Q2
Google and Apple’s RevenueEconomies of Scale & Economic Welfare
Economies of scale can lead to higher consumer and producer surplus – this is an
important argument to use when evaluating monopolistic markets

18. Output (Q)
Cost & Price
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Profit at
price P1
Google and Apple’s RevenueEconomies of Scale & Economic Welfare

19. Output (Q)
Cost & Price
AC1
AC2
MC1
MC2
AR
MR
Q1
P1
Q2
P2
Profit at
price P1
Profit at
price P2
Google and Apple’s RevenueEconomies of Scale & Economic Welfare

20. Output (Q)
Cost & Price
AC2MC2
AR
MR
Q2
P2
Consumer surplus at P2
Google and Apple’s RevenueEconomies of Scale & Economic Welfare
Consumer surplus is higher because market price is lower and output is higher

21. Internal
economies of scale
Expansion of the firm itself
Lowers long run average
cost (LRAC)
Efficiencies from larger
scale production
Range of economies e.g.
technical & financial
External
economies of scale
Expansion of the industry
Benefits most / all firms
Agglomeration economies
are increasingly important
Helps to explain the rapid
growth of many cities
Google and Apple’s RevenueInternal and External Economies of Scale

22. Internal
economies of scale
Expansion of the firm itself
Lowers long run average
cost (LRAC)
Efficiencies from larger
scale production
Range of economies e.g.
technical & financial
External
economies of scale
Expansion of the industry
Benefits most / all firms
Agglomeration economies
are increasingly important
Helps to explain the rapid
growth of many cities
Google and Apple’s RevenueInternal and External Economies of Scale

23. External economies of scale (EEoS) occur outside of a firm but
within an industry – they arise from the growth of an industry
Output
LRAC1
B
Internal Economies of Scale
A
Cost
(per unit
of output)
Google and Apple’s RevenueExternal Economies of Scale

24. External economies of scale (EEoS) occur outside of a firm but
within an industry – they arise from the growth of an industry
Output
LRAC1
B
Internal Economies of Scale
A
Cost
(per unit
of output)
LRAC2 (EEoS)
External
Economies of
Scale (EEoS)
Google and Apple’s RevenueExternal Economies of Scale

25. University Research
Departments helping
to fun research
Transport Networks
lower logistics costs
Relocation of Suppliers
to the centre of
production
Influx of human capital
– highly skilled
workers
Agglomeration economies are
important.
Businesses in similar
industries cluster together
and attract an influx of skilled
talent which then provides
human capital to expanding
businesses.
Google and Apple’s RevenueExamples of External Economies of Scale
External economies of scale
involve changes outside of
the business i.e. they result
from the expansion of the
entire industry of which the
business is a member. They
lower unit costs for many /
all firms inside the market

26. • All businesses can exploit some internal economies of scale
• The nature of production / technology requirements will
influence the size of MES relative to market demand
• Economies of scale may run out at a certain point but
constant returns to scale means that unit cost will be stable
• Much depends on businesses achieving a high rate of
capacity utilisation – this then lowers the fixed cost per unit
• Dynamic pricing strategies help businesses to do this
• Small businesses can still thrive and prosper even in markets
dominated by scaled businesses – they target market niches
• For the exam, have some good applied examples to use as
application for each internal & external economy of scale
Google and Apple’s RevenueEvaluating Economies of Scale

27. Economies of scope happen when it is cheaper to produce a range
of products rather than specialize in a limited number
Hypermarkets Amazon Proctor & Gamble
Google and Apple’s RevenueEconomies of Scope
Economies of Scope and Merger Deals: Proctor and Gamble and Gillette
The difference between economies of scale and economies of scope is the difference
between “more of the same” and “more of something similar.” The P&G / Gillette merger
may allow products more to be sold through common branding, channels, and logistics.

28. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2 Q3
Economies of
scale cause
AC to fall
Lowest point on LRAC
is output of
productive efficiency
Diseconomies of scale come from decreasing returns to scale
Rising LRAC – means
diseconomies of scale
Google and Apple’s RevenueDiseconomies of Scale

29. • Diseconomies lead to a rise in a firm’s LRAC
• They result from a business expanding beyond an optimum
size and thereby losing productive efficiency
• Diseconomies of scale may be due to:
1. Control – there are problems in monitoring productivity and
work quality, increasing wastage of scarce resources
2. Co-operation - workers in large firms may develop a sense
of alienation and loss of morale, they may have little
autonomy in how they approach tasks / projects
3. Negative effects of internal politics including information
over-load, unrealistic expectations held by managers and
cultural clashes between senior people with inflated egos
Google and Apple’s RevenueCauses of Diseconomies of Scale

30. Higher Regulatory Costs
for bigger Businesses
Office Politics / Industrial
Relations
Risk aversion among
salaried staff
Waste / Inefficiency in
large organisations
Google and Apple’s RevenueCauses of Diseconomies of Scale
“The law of large numbers
militates against large
corporations; they tend to
become too complex and
inflexible as they expand,
which inhibits their ability
to adapt.”
Source: Luke Johnson, Financial
Times, December 2014
“In organizations with
highly complicated process
structures, managers
devote 40% of their time to
creating reports and as
much as 60% of their time
to meetings.”
Source:
Forbes Magazine, March 2016

31. • Diseconomies of scale are increases in the unit
cost of supply in the long run
• Diseconomies of scale mean that
– A business has moved beyond their optimum size
– Businesses are suffering from productive inefficiency
– Higher unit costs will reduce total profits
– Businesses may then have to charge higher prices in
order to cover their increased costs
– Lost competitiveness could lead to declining market
share and also a fall in their share price
Google and Apple’s RevenueEffects of Diseconomies of Scale

32. Economies and
Diseconomies of Scale and
Market Competition
Economies and Diseconomies of Scale