What are Economies of Scale?

Economies of scale are essentially the cost advantages that a firm can gain by expanding its output. Economies of scale reduce the long run average cost per unit when output expands. It is important to note that economies of scale can only be exploited by large firms, and can only take place in the long run.

There are two main types of economies of scale. Internal economies occur when an individual firm undergoes expansion, whereas external economies occur when an entire industry undergoes expansion. The main difference to note here - internal economies of scale affect only one firm, but external economies of scale affect multiple firms.

Under the umbrella of internal economies of scale, there are various types - depending on the nature of the particular industry.

An example of this would be financial economies of scale. By expanding production, large firms can borrow capital for expansion at a much lower rate of interest than smaller firms. This is because they are less of a financial risk. Large supermarkets like Sainsurys and Tesco can expand at a much lower rate of interest than local corner shops, simply because there is evidence that their venture of expansion is financially sustainable.