Economies of scale
Some economies of scale, such as capital cost of manufacturing facilities and friction loss of transportation and industrial equipment, have a physical or engineering basis.
The economic concept dates back to Adam Smith and the idea of obtaining larger production returns through the use of division of labor.
Common limits include exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry.
A common limit for a low cost per unit weight raw materials is saturating the regional market, thus having to ship products uneconomic distances.
[4] Common sources of economies of scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function).
Conversely, an industry exhibits an external economy of scale when costs drop due to the introduction of more firms, thus allowing for more efficient use of specialized services and machinery.
Heat loss from industrial processes vary per unit of volume for pipes, tanks and other vessels in a relationship somewhat similar to the square–cube law.
[c][5] In some productions, an increase in the size of the plant reduces the average variable cost, thanks to the energy savings resulting from the lower dispersion of heat.
In fact, the greater of the number of resources involved, the smaller, in proportion, is the quantity of reserves necessary to cope with unforeseen contingencies (for instance, machine spare parts, inventories, circulating capital, etc.).
A larger scale generally determines greater bargaining power over input prices and therefore benefits from pecuniary economies in terms of purchasing raw materials and intermediate goods compared to companies that make orders for smaller amounts.
The economies of division of labour derive from the increase in production speed, from the possibility of using specialized personnel and adopting more efficient techniques.
[12] When the size of the company and the division of labour increase, there are a number of advantages due to the possibility of making organizational management more effective and perfecting accounting and control techniques.
Learning by doing implies improvements in the ability to perform and promotes the introduction of incremental innovations with a progressive lowering of average costs.
These economies are due to the presence of some resource or competence that is not fully utilized, or to the existence of specific market positions that create a differential advantage in expanding the size of the firms.
[17] The cost of a unit of capacity of many types of equipment, such as electric motors, centrifugal pumps, diesel and gasoline engines, decreases as size increases.
[20] Many manufacturing facilities, especially those making bulk materials like chemicals, refined petroleum products, cement and paper, have labor requirements that are not greatly influenced by changes in plant capacity.
[21] Marx cited the chemical industry as an example, which today along with petrochemicals, remains highly dependent on turning various residual reactant streams into salable products.
Large and more productive firms typically generate enough net revenues abroad to cover the fixed costs associated with exporting.
In Das Kapital (1867), Karl Marx, referring to Charles Babbage, extensively analyzed economies of scale and concludes that they are one of the factors underlying the ever-increasing concentration of capital.
The tendency to exploit economies of scale entails a continuous increase in the volume of production which, in turn, requires a constant expansion of the size of the market.
According to Marx the capitalist system is therefore characterized by two tendencies, connected to economies of scale: towards a growing concentration and towards economic crises due to overproduction.
In the case of agriculture, for example, Marx calls attention to the sophistical nature of the arguments used to justify the system of concentrated ownership of land: Instead of concentrated private ownership of land, Marx recommends that economies of scale should instead be realized by associations: Alfred Marshall notes that Antoine Augustin Cournot and others have considered "the internal economies [...] apparently without noticing that their premises lead inevitably to the conclusion that, whatever firm first gets a good start will obtain a monopoly of the whole business of its trade … ".
[33] Marshall believes that there are factors that limit this trend toward monopoly, and in particular: Piero Sraffa observes that Marshall, in order to justify the operation of the law of increasing returns without it coming into conflict with the hypothesis of free competition, tended to highlight the advantages of external economies linked to an increase in the production of an entire sector of activity.
However, "those economies which are external from the point of view of the individual firm, but internal as regards the industry in its aggregate, constitute precisely the class which is most seldom to be met with."
"In any case - Sraffa notes – in so far as external economies of the kind in question exist, they are not linked to be called forth by small increases in production," as required by the marginalist theory of price.
In this book, Sraffa determines relative prices assuming no changes in output, so that no question arises as to the variation or constancy of returns.
In 1947, DuPont engineer Roger Williams, Jr. (1930-2005) published a rule of thumb that costs of chemical process are roughly proportional to the tonnage in power ~0.6.
[37] In the following decades it became widely adopted other engineering industries[16][38] and terrestrial mining,[39] sometimes (e. g., in electrical power generation) with modified exponential scaling factors.
[43] If, on the other hand, the analysis is expanded, including the aspects concerning the development of knowledge and the organization of transactions, it is possible to conclude that economies of scale do not always lead to monopoly.
[45] Advantages that arise from external economies of scale include; Firms are able to lower their average costs by buying their inputs required for the production process in bulk or from special wholesalers.
