Economies Of Scale

Published Dec 26, 2022

Definition of Economies of Scale

Economies of scale is defined as the cost advantage that arises with increased output of a product. That means as production increases, the average total cost of each unit decreases because of the efficiencies that come with larger production volumes.

Example

To illustrate this, let’s look at a hypothetical company that produces widgets. The company has a fixed cost of USD 10,000 per month for rent, salaries, and other overhead expenses. In addition, it has variable costs of USD 1.00 per widget. If the company produces 1,000 widgets, its total cost adds up to USD 11,000 (i.e., 10,000 + 1,000). That means the average cost per widget is USD 11.00 (i.e., 11,000/1,000).

Now, if the company doubles its production to 2,000 widgets, its total cost adds up to USD 12,000 (i.e., 10,000 + 2,000). That means the average total cost per widget is now USD 6.00 (i.e., 12,000/2,000). Or in other words, the company has achieved economies of scale and can produce widgets at a lower cost per unit.

Why Economies of Scale Matter

Economies of scale are an important concept for businesses of all sizes. On the one hand, they enable companies to produce goods and services at a lower cost. That, in turn, allows them to increase their profits and become more competitive in the market. On the other hand, economies of scale also benefit consumers. That’s because they enable companies to produce goods and services more efficiently, which allows them to reduce prices for consumers as well.