What are economies of scale and scope?

Economies of scale and scope

The concept of economies of scale were introduced by Adam Smith as a part of his famous works on division of labour. The main idea behind it is that efficiency of production changes as the size of production varies. Usually, as company grows, it experiences increased efficiency of production to a point, where disadvantages of growing bigger exceed economies of scale. In that case, diseconomies of scale happen. To provide an example, when bakery owner decides to employ more people in his bakery and increase sales in his shop, he will most likely experience economies of scale, as he will still be paying the same rent and would not need any major investments in additional equipment. If he would like to grow further though and set up a whole chain of his bakeries, he will need to not only fully equip all his new shops, but also create a managerial structure, as he would not be able to handle it all himself now. That might lead to decreasing efficiency and therefore diseconomies of scale.

Most common reasons for economies of scale are better division of labour, more efficient trading and sales (buying raw resources is cheaper in greater volumes, global brands are better known compared to local ones etc.) technology becomes relatively cheaper (big companies can afford their own labs). On the other hand, most common diseconomies of scale are managerial costs, bureaucracy, inflexibility, slow response time, principal-agent problem (in big companies, manager and owner are usually two different people/groups of people, and their interest might not always be the same).

Along with economies of scale goes economies of scope. These are not based on size, but on the breadth of the products the company produces. Economies of scope can only be positive and occur, when synergies between production of different goods by one company appears. Example can be car producer which also produces buses. The firm has already developed its engines technology, which can be after some modifications also used for buses, so the company is producing them cheaper than if it was focused solely on buses.