Introduction
Enterprise scale economy refers to the significance and rate of the increase in the total economic benefit of an enterprise when its scale of production is expanded under certain conditions. When the production scale of an enterprise increases, the total return will increase, but the marginal return will decrease at the same time, which is the principle of diminishing marginal returns. The realization of economies of scale can reduce production costs, leading to increased profits, and also can play a vital role in the establishment of competitive edges in the market for enterprises.
Theories of Economies of Scale
Economies of scale are usually considered to fall into two categories in economics, which are internal and external economies.
(1) Internal Economies of Scale
Internal economies of scale can be defined as those efficiencies a firm can achieve by increasing the size of their production. The realization of internal economies of scale lies in large-scale production that can reduce unit costs, so enterprises can contract production costs, which can give a relatively lower average cost, or unit cost of production, when increasing production scale. This can enable enterprises to have a greater profit margin.
(2) External Economies of Scale
External economies of scale exist outside the firm, while still benefiting the firm in the form of lower costs and increased production. Agglomeration economies are the most common type of external economies of scale. They include the value generated from having an industry concentration in the same area. Firms can benefit from these external economies of scale by tapping into the existing infrastructure, talent pool, and the existing pool of customers.
Sources of Economies of Scale
Economies of scale come from both internal and external factors, but what are these sources specifically?
(1) Specialization
In large-scale production, enterprises can produce more specialized products, with higher quality at a lower cost. Specialization can not only reduce the production costs of enterprises, but also reduce the storage costs.
(2) Market Power
Market power is the ability of a firm to make production and pricing decisions that are not available to smaller firms in the market. This can enable the larger firm to have an edge on pricing and output, which can ultimately generate more economies of scale for the enterprise.
(3) Bulk Buying
Bulk buying refers to the practice of purchasing large quantities of materials from the suppliers. The obvious benefit of this large scale purchase is that the enterprises can enjoy large discounts from the suppliers. It is a common method to reduce production costs and realize economies of scale.
(4) Branding
Branding or advertising can create economies of scale, as large corporations are best placed to benefit from allowing customers exposure to their products on a larger scale. This not only means that a larger base of customers can reach, but also can give the firms a competitive edge in their market.
Conclusion
Economies of scale can enable firms to reduce costs and enjoy higher profits. It is an inevitable trend for firms to increase their production scale in order to realize economies of scale. Yet, the conditions of different markets are different, which means that enterprises should exploit the economies of scale from internal and external sources according to their specific situations.
