Definition: Economies of scale occur when average costs decrease as output increases.

These cost advantages can be categorised into internal and external economies of scale.

Internal Economies of Scale

Definition: Internal economies of scale occur when a firm’s average costs decrease as output increases.

Types of internal economies of scale:

Financial - When larger businesses are able to access loans at cheaper interest rates due to being lower risk and more creditworthy.
Managerial - Large firms are able to employ specialised managers which improve efficiency and productivity.
Marketing - Large firms spread the cost of advertising over a larger output, reducing the cost per unit.
Purchasing - When firms bulk-buy or purchase materials in large quantities, allowing them to secure discounts.
Technical - Larger firms are able to invest in specialised machinery or technology, improving production efficiency.
Risk-bearing - The ability of large firms to spread risks across a range of products or markets, reducing the impact of potential losses from any single product.

External Economies of Scale

Definition: External economies of scale occur when a firm's average costs decrease due to factors outside the firm, within the same industry.

Types of external economies of scale:

Skilled labour - As an industry grows, specialized and experienced workers may be attracted, reducing recruitment and training costs for firms while increasing efficiency.
Infrastructure - Improvements in roads, transportation, utilities, or communication systems can benefit businesses within a specific industry by lowering delivery times and operational costs.
Government support - Policies such as subsidies, tax cuts, or favourable regulations help reduce production costs for certain businesses.
Geographical — Firms can benefit from being in close proximity to one another by gaining access to shared resources such as suppliers and labour which can help lower costs.

Definition: Diseconomies of scale occur when a firm's average total costs increase as its output increases.

Causes of diseconomies of scale (limits of growth):

Lack of motivation - Employees in large businesses may feel disengaged or undervalued due to the excessive layers of management. This can decrease output and efficiency.
Bureaucracy - Increased layers of management in large businesses may lead to slow-down decision-making or ineffective communication.
Inefficient resource allocation - Larger firms may find difficulty in allocating resources efficiently as they might invest in projects or areas with diminishing returns, wasting resources that could have been better used elsewhere.
Government regulation - As firms expand, they may face stricter regulations and taxes which increase total costs.