Economies of Scale

Economic Models

Economies of Scale

Economies of scale, also called increasing returns to scale, refers to the situation in which the cost of producing an additional unit of output (i.e., the marginal cost) of a product decreases as the volume of output (i.e., the scale of production) increases.

It is important to understand the concept of economies of scale because they can be an important factor in determining the optimal and equilibrium size of firms and thus the structure of industries and their prices and output levels.

Often, large firms in industries with high fixed costs can take advantage of savings that smaller firms cannot. Economies of scale characterizes a production process in which an increase in the scale of the firm causes a decrease in the long run average cost per unit. Economies of scale can be enjoyed by any size firm expanding its scale of operation.

Marginal Cost

Marginal cost can decrease as the volume of output increases for several reasons. One is that larger production volumes allow fixed costs to be spread over more units of output.

Fixed Costs

Fixed costs are costs that do not change regardless of the amount of use, or at least change relatively little as a function of use. That is, they are costs that must be incurred even if production were to drop to zero. Examples of fixed costs could include factories, warehouses, machinery, electrical transmission systems and railways.

In IndustryMasters the economies of scale is implemented by Overhead Costs and the effects of expanding a Business unit. A 1x business unit (i.e. Small Cars) incurs the same amount of overhead cost as a 2x business unit. When expanding the business unit from 1x to 2x the overhead cost per unit fall and therefore generate economies of scale.