Economics, 3rd Edition

The Implications of Economies of Scale

Economies of scale are the advantages of large-scale production that result in lower average or unit costs.

Imagine a firm which makes bricks. The current plant has a maximum capacity of 100,000 bricks per week 

and the total costs are 

€200,000 per week. The average cost for each brick, therefore, is €2. The firm sets 

a price of 

€2.20 per brick giving it a profit margin of €0.20 per brick.

E

i

CASE STUDY

Total costs: 

€200,000

per week

Max. capacity: 100,000

per week

Max. revenue 

=

€220,000 per week

Price per brick: 

€2.20

Average cost per brick 

= €2.00

Company size

Demand

---

CHAPTER 6  BACKGROUND TO SUPPLY: FIRMS IN COMPETITIVE MARKETS  149

Now imagine that, in the long 

run, the firm expands. It doubles 

the size of its plant. The total 

costs, obviously, increase – they 

are now using more land and 

acquire more capital, as well as 

hiring extra labour and buying 

more equipment and raw mater-

ials. All of this expansion will 

increase the total cost. However, 

it is not the case that a doubling 

of capacity will also lead to a 

doubling of the cost.

Assume TC is now 

€350,000 

per week. The expansion of the 

plant means that the firm can 

double its output so its capacity is 

now 200,000 bricks per week. The 

percentage increase in the total 

costs is less than the percentage 

increase in output. Total costs 

have risen by 

€150,000 or 75 per 

cent and total output by 100 per 

cent, which means that the aver-

age cost per brick is now 

€1.75.

The firm now faces two scenarios. In 

Scenario 1, the firm could maintain its price 

at 

€2.20 and increase its profit  margin on 

each brick sold from 

€0.20 to €0.45. Assuming 

it sells all the bricks it produces its revenue 

would increase to 

€440,000 per week.

In Scenario 2, the firm might choose to 

reduce its price to improve its competitive-

ness against its rivals. It could maintain its 

former profit margin of 

€0.20 and reduce 

the price to 

€1.95. In this case, if it sells all 

it produces its revenue would be 

€390,000 

per week.

What the firm chooses to do would be 

dependent on its competitive position. If it 

played a dominant role in the market it might 

be able to increase its price and still sell all 

it produces. If it was in a more competitive 

market it might not have sold all its capacity 

in the first place so being able to reduce its 

price might mean that it can now increase 

sales against its rivals and increase its total 

revenue as a result.

Economies of scale, therefore, occur where the proportionate rise in output as a result of the expan-

sion or growth of the firm, as defined by a rise in all the factor inputs, is greater that the proportionate rise 

in costs as a result of the expansion.

Total costs: 

€350,000

per week

Max. capacity: 200,000

per week

Max. revenue 

=

€390,000 per week

Price per brick: 

€1.95

Scenario 2

Average cost per 

brick 

= €1.75

Company size

Demand

Total costs: 

€350,000

per week

Max. capacity: 200,000

per week

Max. revenue 

=

€440,000 per week

Price per brick: 

€2.20

Scenario 1

Average cost per brick 

= €1.75

Company size

Demand

---