When do economies of scale become diseconomies of scale

Examples include inefficient communication, lack of motivation, greater sick days, lack of responsibility, or ownership of tasks. Communication Organisational diseconomies occur when the firm expands. In turn, new departments open alongside new employees.

For all involved, it can create a minefield. To get something done, an employee may need to go through various departments to find assistance. The big successful firms tend to resolve such issues. Although some inefficiencies may still occur. Demotivation As the firm grows bigger, there are also psychological issues that can arise. For instance, being one of the , employees can create a feeling of insignificance.

Furthermore, managers may easily overlook any individual successes. As a result, employees can feel demotivated, thereby under-performing and creating inefficiencies. Employee Health As stated previously, employees can feel like just another cog in the wheel of a big firm. However, big firms can also create a feeling of isolation for many. When there is a set and standard procedure to follow, it can feel rather robotic. This sense of isolation and insignificance not only affects motivation, but also health.

In turn, employees may take off more sick days, become less productive, and also be less innovative. Sometimes, big firms can end up paying more than it would as a small company. If we think of Google, Apple, or Microsoft, they all have significant levels of cash flow.

As a result, it is inevitable that such firms end up overpaying for various goods. One example includes Apples purchase of Beats back in Naturally, if a big firm wants an asset, good, or service, it is willing and able to do so despite the price. This is because it has both the desire and resources — something a smaller firm may not be able to. Higher Costs As firms become increasingly willing to spend more, they are more likely to overpay for goods and services.

In turn, this will end up impacting their bottom line. Greater Waste As a firm gets bigger, there becomes a disconnect between management and the average employee. Consequently, the needs of the worker are often forgone and overlooked. Management may buy resources employees do not need or want. Deadlock Some large firms recognise that there are levels of reckless spending. As a result, purchasing decisions may go through round after round of approval, eventually getting blocked at the last stage.

In turn, the firm may not actually progress. Strong and competitive markets are key to keeping businesses efficient. When there is little competition, there is less pressure to reduce costs. For instance, a firm that owns a monopoly has little incentive to reduce costs and increase efficiencies as there is no competition that may put it out of business. At the same time, customers do not have an alternative so are forced to pay for the price. As a result, non-competitive markets tend to have higher costs than under competitive conditions.

Competition can be worn down over time as a firm grows bigger and bigger. For instance, Amazon has grown at a rapid pace and now has a strong position in the eCommerce market. Although it does not have a monopoly, it has little in the way of competition. In turn, such large companies may suffer from inefficiencies if management do not keep on top of the numerous issues that may result.

When there is little competition, there is less pressure on management to do so. In addition, high profits with large costs, acts as a signal to potential competitors.

Higher Costs : Companies that have significant market share usually have thousands of employees. As a result of its strong positioning, it may find management does not have the same incentives to implement universal efficiencies within the firm. As a firm grows bigger, it may look to buy new factories or real estate. In turn, it will require new sources of funding.

If these are no organically raised, they will come from external sources such as banks or other financial instruments. As a result, the firm will have to repay interest. This creates an additional cost that smaller firms do not always have. As costs of financing increases, so too do the costs of managing financial records. More accountants and legal teams may be required. In turn, the final cost of production can increase if productivity does not grow over and above these costs.

Expanded Workforce : Borrowing more assets requires more employees to oversee the finances, as well as to manage those resources. As the firm needs to hire more workers, it may also need to borrow more. High Levels of Interest : When a firm uses external finance to grow inorganically, it can become increasingly expensive to continue.

The more a firm borrows, the riskier it becomes for investors. In turn, lenders account for the risk with higher interest rates. External diseconomies refer to costs that increase due to factors outside of the company but impact the whole industry. In other words, as the industry grows, diseconomies impact the firm as well as the wider industry.

As an industry grows larger, it can create additional costs to the local or national population. For example, several factories may open in close proximity to each other in order to benefit from efficiencies. This may come from knowledge efficiencies, supplier efficiencies, or other such efficiencies. As a result, such factories may create additional costs in the form of pollution to its local surroundings. The long-run average cost curve shows the cost of producing each quantity in the long run, when the firm can choose its level of fixed costs and thus choose which short-run average costs it desires.

If the firm plans to produce in the long run at an output of Q 3 , it should make the set of investments that will lead it to locate on SRAC 3 , which allows producing q 3 at the lowest cost. At SRAC 2 the level of fixed costs is too low for producing Q 3 at lowest possible cost, and producing q 3 would require adding a very high level of variable costs and make the average cost very high.

At SRAC 4 , the level of fixed costs is too high for producing q 3 at lowest possible cost, and again average costs would be very high as a result. The shape of the long-run cost curve, in Figure 3, is fairly common for many industries. The left-hand portion of the long-run average cost curve, where it is downward- sloping from output levels Q 1 to Q 2 to Q 3 , illustrates the case of economies of scale.

In this portion of the long-run average cost curve, larger scale leads to lower average costs. We illustrated this pattern earlier in Figure 2. In the middle portion of the long-run average cost curve, the flat portion of the curve around Q 3 , economies of scale have been exhausted. In this situation, allowing all inputs to expand does not much change the average cost of production.

We call this constant returns to scale. In this LRAC curve range, the average cost of production does not change much as scale rises or falls. The concept of economies of scale, where average costs decline as production expands, might seem to conflict with the idea of diminishing marginal returns, where marginal costs rise as production expands. But diminishing marginal returns refers only to the short-run average cost curve, where one variable input like labor is increasing, but other inputs like capital are fixed.

Economies of scale refers to the long-run average cost curve where all inputs are being allowed to increase together. Thus, it is quite possible and common to have an industry that has both diminishing marginal returns when only one input is allowed to change, and at the same time has increasing or constant economies of scale when all inputs change together to produce a larger-scale operation.

Finally, the right-hand portion of the long-run average cost curve, running from output level Q4 to Q5, shows a situation where, as the level of output and the scale rises, average costs rise as well. This situation is called diseconomies of scale. A firm or a factory can grow so large that it becomes very difficult to manage, resulting in unnecessarily high costs as many layers of management try to communicate with workers and with each other, and as failures to communicate lead to disruptions in the flow of work and materials.

Not many overly large factories exist in the real world, because with their very high production costs, they are unable to compete for long against plants with lower average costs of production. However, in some planned economies, like the economy of the old Soviet Union, plants that were so large as to be grossly inefficient were able to continue operating for a long time because government economic planners protected them from competition and ensured that they would not make losses.

Diseconomies of scale can also be present across an entire firm, not just a large factory. Techinical - machinery, buildings etc are paid for as a fixed amount. Purchasing economies of scale:.

Large firms are able to negotiate more favourable terms when buying raw materials etc. Bulk buying - remember it is the cost per unit of buying in bulk not the total cost Great example is supermarkets and local shop.

Financial - similar in principle to buying in bulk but this time interest rates a more favorable. Reasons for diseconomies of scale. Communication - becomes more complex. X- Inefficiency - management costs increase non-productive costs.