Scale effects

In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation (typically measured by amount of output produced), with cost per unit of output decreasing with increasing scale.

Economies of scale apply to a variety of organizational and business situations and at various levels, such as a business or manufacturing unit, plant or an entire enterprise. When average costs start falling as output increases, then economies of scale are occurring. Some economies of scale, such as capital cost of manufacturing facilities and friction loss of transportation and industrial equipment, have a physical or engineering basis.

Another source of scale economies is the possibility of purchasing inputs at a lower per-unit cost when they are purchased in large quantities.

The economic concept dates back to Adam Smith and the idea of obtaining larger production returns through the use of division of labor.Diseconomies of scale are the opposite.

Economies of scale often have limits, such as passing the optimum design point where costs per additional unit begin to increase. Common limits include exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry. A common limit for low cost per unit weight commodities is saturating the regional market, thus having to ship product uneconomical distances. Other limits include using energy less efficiently or having a higher defect rate.

Large producers are usually efficient at long runs of a product grade (a commodity) and find it costly to switch grades frequently. They will therefore avoid specialty grades even though they have higher margins. Often smaller (usually older) manufacturing facilities remain viable by changing from commodity grade production to specialty products.

The simple meaning of economies of scale is doing things more efficiently with increasing size or speed of operation. Economies of scale often rely on fixed costs, which are constant and don't vary with output, and variable costs, which can be effected with the amount of output. In wholesale and retail distribution, increasing the speed of operations, such as order fulfillment, lowers the cost of both fixed and working capital. Other common sources of economies of scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function). Each of these factors reduces the long run average costs (LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to the right.

...
Wikipedia