Economies of scale and diseconomies of scale are used to explain why average total cost curves are U-shaped. Economies of scale explain why the average total cost of a growing business first starts to decline while the diseconomies of scale explain why at a certain point the average cost begins to go up.
Economies of scale, also known as economies of mass product, states that many factors lead to lower average costs of production in the beginning. One of the biggest cost savers is labor specialization, which means hiring more workers that are all specialized in a different area of production in order to have maximum efficiency. This will lead to lower production costs (because it will take less time to complete a task when done by someone proficient at it) and means that workers that are skilled at one part of production won’t have to waste time completing tasks they aren’t as good at. Another factor that is considered is management, which can have a big effect on how efficiently a business is being run. Management specialists for different functions like marketing or finance is better than one manager trying to balance all of it. With specialists in each division, they will be able to better see where costs can be cut down and how operations can be run the best way possible.
Diseconomies of scale explain why, after time, average cost begins to rise. The main cause of it is that companies become too large scale that they can no longer efficiently control their business. The book explains that in a smaller business, an executive that makes decisions takes into account “the production line, understands the firm’s operations...and make efficient decisions.” Once a business has several levels that don’t communicate with one another, many people at the top may make decisions that do not necessarily utilize their resources in the most efficient way but because they don’t have all the information there is no way for them to know that. An example of this could be that a manager of production sees that a certain branch of their company is not shipping out as many units as others are. This manager may hand off this issue to a lower level employee and task them to fix it. This employee may just go ahead and order that more equipment be sent to this branch, thinking that they cannot make enough product in time because they don’t have enough machines. However, what if the reason this branch was not producing enough input is because it was not well organized with specialized workers? Equipment is often very expensive and this incorrect use of resources could cost the company more money than necessary.
As you can see, both economies and diseconomies of scale help explain the average total cost curve and its U shape.
This was actually a really good explanation on why the cost ends up rising. I understood why it would go down at first, but I didn't understand why it then rose, but this cleared it up. It makes a lot of sense that a large business would not have the time to make sure all the resources are allocated correctly, which drives costs up. For example, when a business tries to pen another location, it is a huge risk economically. The average costs go way up because there is now more utilities to pay and the owner isn't able to personally manage everything, which means either resources are wasted or another manager should be hired, which also raises costs.
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