Costs

Costs of Production are the amounts paid by
the producer to get the good or service ready for
sale.
 These may include wages, rent, raw materials,
packaging, interest and advertising.

Total cost is the sum of all the costs involved in
getting the goods or service ready for sale.

Average cost of production is the cost per unit
of output. Equals total cost divided by output.
Economies of Scale
As a firm becomes larger (increases
its level of output) the average costs
begin to fall= Economies of scale

Even though the total cost grows,
the total output grows by more
Average Cost = Total cost
Output
Productivity will increase because you
are able to produce more with the
same resources
Economies of Scale

When there are economies of scale
there is a larger increase in output than
the increase in inputs.

E.g. If there is a 5% increase in
resources (inputs) but a 10% increase in
production (outputs) then there are
economies of scale.
Reasons for economies of
scale
Economies of
Scale
(falling Average Costs)
Technical economies
•More Specialisation
•More R&D
•Indivisibility of
machinery
Marketing economies
Financial economies
•Bulk buying
•Specialist buyers
•Lower cost of advertising
for each unit sold
•Lower interest rates
•Greater access to funds
Reasons for Economies of Scale

Technical Economies
○ Bigger businesses are able to afford more advanced
(expensive) machinery to increase productivity. Smaller firms
may be unable to afford this machinery. Larger firms are also
able to benefit from mass production methods of production,
such as division of labour, which increases productivity.

Marketing Economies
○ Many marketing costs (advertising) stay the same regardless
of the output being produced. Larger firms can spread these
costs over larger output, reducing the cost per unit.
○ Larger firms can buy in bulk, so can negotiate discounts from
their suppliers so cost per unit will fall ( supermarkets)
○ Larger firms can also hire staff that specialise in buying inputs
for the best price
Reasons for Economies of Scale

Financial Economies
 Larger firms have the benefit of being able to obtain
loans more easily. As larger firms usually have more
assets so are seen as being more credit worthy. Larger
firms can also negotiate lower interest rates on their
loans and overdrafts. Lowering the average cost of
production

Managerial Economies
 Larger firms can employ specialist managers who can
focus on each area of production. For example one
person could be employed as a manager to deal with
staff, another to deal with marketing and another for
finance etc.
Diseconomies of scale

This is when the Average cost of production starts
to increase as the size of the business increases.

This is due to inefficiency and problems with
management, perhaps the productivity of workers
falls or there are production line hold ups.

Management issues are the main cause of
diseconomies of scale.
 Communication breaks down between management and
employees ( productivity may fall)
 Workers may not feel as appreciated, less motived.
 Workers may become board ( Division of labour)
Consequences


Economies of scale result in lower average costs.
If the selling price remains the same it will result in a
greater difference between revenue earned and the
costs, making a greater profit for the business.

Firms may decide to lower the selling price of their
product but keeping the profit margin the same. This
makes goods cheaper for consumers so the firm will
attract more customers and increase its market
share- and generate more revenue.

When diseconomies of scale arise the firm will loose
profits or they must increase prices. This may result
in less market share