Notes:

Economies of Scale

The basic notion of economies of scale is well known: As a plant gets larger and volume increases, the average cost per unit of output drops. This is partially due to operating and capital costs' decline since a piece of equipment with twice the capacity of another piece does not cost twice as much to purchase or operate. Plants also gain efficiencies when they become large enough to fully utilize dedicated resources for tasks such as material handling. The remaining cost reductions come from the ability to distribute non-manufacturing costs such as marketing and R&D over a greater number of products.

This reduction in average unit cost continues until the plant gets so big that coordination of material flow and staffing becomes so expensive that new sources of capacity must be found. This concept can be related to best operating levels by comparing the average unit cost of different sized plants. Exhibit 8.2 shows the best operating levels for 100-, 200-, 300-, and 400-unit (per year) plants. The average unit cost is shown as dropping from best operating level to best operating level as we move from 100 to 300 units. Diseconomies of scale would be evidenced if we had, say, a 400-unit plant where cost was higher than for the 300-unit plant. However, moving to the right along any of the three average cost curves would not be evidence of diseconomy of scale because the plant size has not increased. Rather, it would indicate that management has tried to get more from the plant than it can most efficiently provide.