Economies of Scale Definition
Define Economies of Scale In Simple Terms
Economies of scale refers to cost advantages experienced by companies as they grow and become more efficient.
An economy of scale is realized as a company increases in size and is able to spread out the cost of production over a larger number of units of a good.
What Does Economies of Scale Mean In Finance?
Companies use economies of scale to maximize the efficiency of production.
Generally speaking, as a company produces more units of a good, the cost per unit goes down because operating and overhead costs get spread out over more products, leading to increased margins.
This is one reason why a smaller company will charge more for a product than a larger company making the same product.
Economies of Scale Example (Internal vs. External)
Economies of scale can be either internal or external.
Internal economies of scale are realized through cost changes within a single company.
This could occur when a company reaches a sufficient scale of production or through decisions from management.
A large company might be able to buy materials in bulk for example, or they might have a special patent or technology that lets them produce goods more efficiently.
External economies of scale are achieved within an entire industry.
This could again be due to a new technology that increases productivity, a more skilled labor pool, tax incentives, and so on; anything that can reduce production costs for many companies in an industry.