5.1 Economies and diseconomies of scale
- Syllabus
- 2026
- Topic
- 5.1
- Level
- —
Learning objectives
Explain why scale can lower average total cost
Economies of scale occur when average total cost falls as output increases. The relevant result is cost per unit, not simply a fall in total cost: total cost may rise while it is spread or controlled more efficiently across much more output.
averagetotalcost=totalcost/output
| Source | Mechanism | Example effect |
|---|---|---|
| internal economy of scale | growth inside the business changes how its own resources are bought or used | bulk purchasing discounts; specialist managers; efficient machinery; finance or promotion costs spread across more units |
| external economy of scale | growth or improvement in the industry/location changes conditions outside one business | stronger supplier networks, transport/infrastructure or a larger pool of trained workers lowers operating cost for firms in the area/industry |
If total cost rises from £80,000 for 10,000 units to £120,000 for 20,000 units, average total cost falls from £8 to £6 per unit. The business has grown and total cost is higher, but each unit carries £2 less cost.
Lower unit cost may allow a lower price, a higher margin or investment in quality and promotion. The benefit depends on selling the increased output and maintaining quality, coordination and capacity use.
Internal economies arise from the individual business's own expansion; external economies arise from changes outside it that may benefit several firms. Growth does not guarantee either type, and a lower average cost does not by itself guarantee higher total profit.
Recognise when growth starts raising unit cost
Diseconomies of scale occur when average cost per unit rises as a business grows beyond the scale it can manage effectively. The organisation becomes harder to coordinate, so lost productivity and added control costs can outweigh earlier scale benefits.
| Growth pressure | Causal chain to higher average cost |
|---|---|
| communication | more layers/sites/people → messages become slower or distorted → errors, delay and duplication use more resources per unit |
| coordination | more products and operations → scheduling and control become complex → idle time, waste or inconsistent decisions raise unit cost |
| employee motivation | workers feel remote or have less responsibility → engagement/productivity falls → more labour time is needed per unit |
| bureaucracy | more rules, meetings and approvals → administration and decision time increase → overhead per useful unit rises |
The limit to growth is reached when an additional expansion is expected to add more coordination and control cost than scale savings. Managers can respond through delegation, clearer structures, decentralised decisions, suitable systems, training or by slowing/reversing expansion.
Track average total cost alongside productivity, quality, delays, staff turnover and customer service. A temporary rise caused by new capacity or training is not automatically a lasting diseconomy; investigate the cause and time horizon.
Diseconomies of scale are about rising average unit cost caused by excessive organisational scale, not any increase in total cost or a one-off input-price rise. There is no universal maximum size: limits depend on technology, management, geography and business complexity.