To a firm, it aims at maximize profit. When firm increasing the scale of production during long run, it can experience the economies of scale in which average cost is decreasing. Although increasing size can bring many advantages, it also brings disadvantage like diseconomies of scale. In this essay, I am going to talk about how economies of scale are mostly technical, tangible and visible and how diseconomies of scale are mostly human, intangible and invisible in the first part. Since diseconomies of scale arise from managerial problem, so in the second part, I am going to discuss the implication of business management.
For example, how to get benefit of economies of scale and to decrease the diseconomies of scale. The economies of scale that is focusing in this essay is internal economies of scale. 'Internal economies of scale are those which arise from the growth of the firm independently of what is happening to other firms. They are not due to any increase in monopoly power or to any technological innovation; they arise quite simply from an increase in the scale of production in the firm itself. ' (Stanlake & Grant P. 64) When a firm increasing the output and make the average cost lower. This firm experiences the economies of scale.
Economies of scale only arise in long run because all factors are variable. In the theory of economies of scale, it assumes that unit cost may change as a firm change in size. Internal economies of scale can be divided into plant economies of scale and firm economies of scale. At plant level, it is also called technical economies because it can improve production efficiency through using machine to lower the average cost. Different firms use different machinery to produce their output. But sometimes when the machines are expensive and large productive capacity as more output produced, it can fully utilised the machine.
So, average cost decrease. This is called The Principle of Invisibility. Firms used to be divided the production process into different stages and use different types of machine. All machines can be used efficiently with large scale of production. It is called The Principle of Multiples. In reality, we can see Taylorism exist, for example, McDonald's, it is highly specialized the job to let workers handle. When a firm need to use tanker to transport product, the cost is base on the surface area. But output always depends on the volume, for example, carrying oil.
Despite surface area is doubled, volume are more then doubled. So, average cost will be lower when large tankers are used. Thus, we can see that large firm can enjoy the benefit of economies of scale. Moreover, large plant can sell or convert its by-products, for example, sell the manure from horse for commercial purpose. Also, large plant can produce more than one product at the same time, for example, bank can provide bank service and insurance service. At firm level, large firm can employ highly specialized management team to make it more efficient due to the wide division of labour and it can lower the average cost.
From the financial aspect, large firms are more well known and can provide adequate collateral. So, it can get loan of lower interest and greater choice of finance. Supplier will also give discounts to large firms caused by the bulk purchasing of raw materials. It can also lowered the average cost. Only large firm can have the capital and incentive to expand into new market. If they get lose in one marker, they can compensate profit from other market in order to spreading risk. Moreover, large firm will find new sources of supply of raw materials in order to avoid stoppage of supply of raw materials.
Furthermore, large firm can afford huge expenditure on research and development to bring out new techniques to lower average cost of production. In fig. 1, it shows that LRAC of economies of scale is downward sloping which means average cost is decreasing. As more output produce, lower cost it will be. Based on the above information, we can see economies of scale are mostly technical, tangible and visible because all of these are related to machine, expenditure and labour. Large firm can experience the advantage of economies of scale.
However, when a firm expand excessively, it will suffer some disadvantage of economies of scale "As firm grow beyond this optimum size, efficiency declines and average cost begin to increase" (Stanlake & Grant P. 70). it is what we called diseconomies of scale. Due to the firm become too large, internal structure become too complex. It needs to take long time to make decision and it occur higher cost to monitor employees. These will lower the efficiency of production. So, average cost increase. Within a large firm, productions are divided into specialized department, it will be difficult to coordinate the task.
Also, the communications in each department maybe easy bring out problems because firm is too large. When problems of production occur, they need more time to make sure that which department goes wrong. The morale of workers will also not good since it is not easy to make worker feel they are an important role within a large firm. Workers will also feel boring because of the monotonous job. All of these are management problems will affect efficiency of production and increase average cost. This can reflect in fig. 2. In fig. 2, the LRAC curve is upward sloping which means as more output produce, higher cost will occur.
Base on the above explanation of diseconomies of scale, we can see that diseconomies of scale are mostly human, intangible and invisible because human problems cannot be predicted and observed. In the long run, as firm increases large scale of production, it can experience economies of scale and suffer from diseconomies of scale. This can be illustrates in fig. 3. Q represents the minimum efficient scale. This is the lowest level of output at which a firm can produce and by gaining all available economies of scale, the minimum average cost.
Firm should produce at the optimize size. Since experiencing economies of scale will also occur problems. So, it brings out the implication of business management. Hoe to motivate workers and explain how economies of scale cannot apply in every industry is the topics we are going to discuss. To acquire economies of scale, the first condition is highly specialized division of labour. Division of labour can make production more efficient. However, it also has disadvantages. Every workers work on a small and specialized task. They will feel boring on the monotonous job.
When workers have no incentive to work because they do not feel that they have an important role in the firm. These problems are one kinds of disadvantage of economies of scale. In order to lower the diseconomies of scale, company should try to motivate workers. According to Herzberg's Duel factor theory, it points out the job dissatisfaction. If workers do not think themselves as an important part of company, try to explain to them how the company policies are like. Apart from this, improving working environment is also important because if employees working in a harmonic and good environment job satisfaction can be achieved.
Since worker only pay attention to highly specialized task, there will be less communication between each other and feel meaningless in doing the job. Thus, company can be hold some functions such as "food-fest", boat trip, etc in order to give the employees a chance to communicate and learn more about each others. Also, 'A goal is basically a desirable objective the achievement of which is uppermost in the mind of a person. ' (McKenna P. 101) Based on Locke' s goal setting theory, in order to improve motivation of employers at work, they need to set goal that are realistic but challenging.
When people set realistic goal by themselves, they will have great motivation to attain the goal due to the rewards of the goal. Also, employees must accept the goal that is set by the employees and employers must give feedback to let employee to know they are in the right track or not. Worker will also can get great satisfactory if they can achieve the challenging goal and have higher motivation to work. In real life situation, McDonald's is a good example in explaining economies of scale because it have both experiencing economies of scale and suffer from diseconomies of scale.
The highly specialized task in McDonald's help it to experience economies of scale. Nevertheless, it will lead to increase in sunk cost. For example, when three workers cooperate to produce a hamburger together, if only one worker make it wrongly, the finished or unfinished hamburger will be throw away. It increases the sunk cost. So, McDonald's will also hold 'Making perfect hamburger competition' for workers in different branch to let them have more communication between each other and improve motivation.
Thus, we can see that motivating workers is a good solution to decease diseconomies of scale, apart from fully realized the technical economies of scale. As economies of scale is benefit to a firm, but it cannot apply into every industry. Mass production industry can experience economies of scale, however, services industry cannot. It is because services industry provides different services to difficult customers. The services cannot be homogenous due to the difficult demand or requirement of customers. So, face-to-face industries cannot experience economies of scale, but also the industry which will change periodically.
For example, fashion industry and information technology industry. These kinds of industry are changing very quick and also unexpected. Thus, it cannot experience economies of scale because it is too flexible. It is cleared that small firm cannot experience economies of scale because of the limited structure and capital. In technical aspect, they cannot afford highly specialized machine and fully-utilised them because of the small scale of production. It will only lead to increase in average cost. Apart from this, small firm cannot afford huge sales promotion expenditure that can help to increase sales.
The average cost of small firm is relatively higher than large firm. It seems that small firms are poorer than large firms, however, it just depends on which kind of industry. It is because if the industry changing frequently, economies of scale is also useless. For example, fashion industry and information technology industry. These two industries are changing too fast and unpredictable. Beside this, it provides different services to different customers. So, sometimes small firm with simple structure will be more efficient because the transaction cost of monitoring workers are not so high.
(Stanlake & Grant P. 64) In conclusion, we can see that economies of scale are mostly technical, tangible and visible and it brings out diseconomies of scale which are mostly human, intangible and invisible. Since diseconomies of scale arise from management problem, so we should make suggestion to motivate worker to attain efficiency. Also, large firm which can experience economies of scale does not means that it is capable in the market because sometimes small firm can be more efficient than large firm.