Business organisation and environment

Table of Contents

1. Topic pack - introduction
2. 1.1 Nature of business activity - notes
3. 1.1 Nature of business activity - questions
4. 1.2 Types of organisation - notes
5. 1.2 Types of organisation - questions
6. 1.3 Organisational objectives - notes
7. 1.3 Organisational objectives - questions
8. 1.4 Stakeholders - notes
9. 1.4 Stakeholders - questions
10. 1.5 External environment - notes
11. 1.5 External environment - questions
12. 1.5 External environment - simulations and activities
13. 1.6 Organisational planning tools - notes
14. 1.6 Growth and evolution - notes
    1. Economies and diseconomies of scale
    2. Types of economy of scale
    3. Internal and external economies and diseconomies of scale
    4. Economies and diseconomies of scale - examples
    5. Small versus Large Organisations
    6. Internal and external growth
    7. Internal growth
    8. External growth
    9. Joint Venture and Strategic Alliance
    10. Mergers and takeovers
    11. Porter's generic strategies
    12. Franchises
    13. Ansoff matrix
15. 1.7 Growth and evolution - questions
16. 1.7 Growth and evolution - simulations and activities
17. 1.6 Change (HL only) - notes
18. 1.9 Globalisation - notes
19. 1.9 Globalisation - questions
20. Print View

Economies and diseconomies of scale

The level of efficiency of a firm depends on people as well as the equipment used. There is an optimum level of output for a factory where average costs are minimised. We will examine how this optimum cost depends on the scale or size of the factory and on its management style.

Most firms start as small businesses, sometimes owned and operated by a single person. If they are successful they grow and may eventually become very large. Some even expand beyond their home country and become multi-national. Why is it, that entrepreneurs and organisations, seek growth as a major objective?

Growth brings both advantages and disadvantages to a business. These interact, and depending on the nature of the business and the way it is managed, decide the optimum or most efficient size for the business.

This is the area of economies and diseconomies of scale.

Figure 1 illustrates that average cost falls as output increases, with the result that large firms may enjoy lower costs that smaller competitors. This competitive cost advantage allows large firms to have larger profit margins and have more options in pricing policy.

Figure 1: The effect of economies of scale on average cost

Figure 2 illustrates that economies and diseconomies of scale both affect a business from the first expansion. However, as the firm grows the effects of the economies of scale tend to decrease, but the effects of the diseconomies of scale increase as inefficiencies begin to appear. There is an optimal size for a firm, where average costs are at their minimum.

Figure 2: The effect of economies and diseconomies of scale on average cost