Explain why average costs of a business may fall as it experiences growth.

A business may grow and experience lower average costs. This is due to economies of scale, which indicates that rising output results in lower costs. There are many types of economies of scale and it is important to consider the main three types:

Purchasing economies of scale - A business may obtain better deals when purchashing more supplies, in the form of discounts. Consequently, this lowers average cost. Think of going to the shop to buy Fanta. You can buy one can for a pound. But if you run a school cafe during your breaktime, you can buy a multi-pack, where each can will cost 70p. As more students want to buy Fanta from you, you decide to contact Coke and due to your large order you purchase a can at 35p, assuming you will buy 1000 cans. As you buy more, you will receive discounts.

Financial economies of scale - When your company grows, you generate more income. The bank will appreciate the fact that your business generates more money, because for them it means that you are likely to pay off the loan. As risk goes down due to your success, banks will offer you a lower interest rate. Therefore, as the interest rate is lowered, you spend less money paying off your loan, therefore average finance costs will fall. Think of a chicken shop down the road and Apple. Apple is likely to borrow money at a cheaper rate, due to its huge size.

Technical economies of scale - As a business grows, it may invest money into more efficient technologies. For example, they may buy a machine which can produce faster, without any errors. This is likely to reduce the average cost per unit, due to faster and error free production.