Diseconomies of Scale

Definition

Diseconomies of scale refer to the increase in average cost per unit that can occur when a company or industry expands its scale of production beyond an optimal level. This phenomenon is the opposite of economies of scale, where average costs decrease as output increases.

5 Must Know Facts For Your Next Test

1. Diseconomies of scale can occur due to factors such as communication problems, coordination issues, and managerial inefficiencies in larger organizations.
2. As a company grows, it may become more difficult to maintain control and oversight, leading to decreased efficiency and higher average costs.
3. Diseconomies of scale can also arise from increased transportation and distribution costs, as well as the need for more complex administrative and support functions.
4. The point at which diseconomies of scale begin to outweigh economies of scale is known as the optimal scale of production, and it varies across different industries and companies.
5. Diseconomies of scale can have significant implications for a company's entry and exit decisions in the long run, as they influence the firm's cost structure and profitability.

Review Questions

• Explain how diseconomies of scale relate to the concept of explicit and implicit costs, and accounting and economic profit.
  • Diseconomies of scale can lead to an increase in a company's explicit costs, such as labor, materials, and overhead expenses, as the scale of production expands beyond the optimal level. This, in turn, can result in a higher average cost per unit, which would be reflected in the firm's accounting profit. However, from an economic perspective, the higher average costs due to diseconomies of scale would also lead to a decrease in economic profit, as the firm's opportunity costs would rise, reducing the overall profitability of the business.
• Describe how diseconomies of scale can impact a company's costs in the short run and the long run.
  • In the short run, diseconomies of scale may manifest through increased coordination and communication challenges, leading to higher labor costs and reduced efficiency. This can result in a rise in the firm's short-run average cost curve. In the long run, as the company continues to expand its scale of production, diseconomies of scale may become more pronounced, leading to further increases in the firm's long-run average cost curve. This can ultimately limit the company's ability to achieve the lowest possible average cost per unit, affecting its overall competitiveness and profitability.
• Analyze how diseconomies of scale can influence a firm's entry and exit decisions in the long run.
  • The presence of diseconomies of scale can significantly impact a firm's long-run entry and exit decisions. If a company faces increasing average costs due to diseconomies of scale, it may become less profitable to operate at larger scales of production. This can deter new firms from entering the market, as they may not be able to achieve the necessary economies of scale to compete effectively. Conversely, existing firms facing diseconomies of scale may find it more profitable to exit the market or downsize their operations to a more optimal scale, where they can minimize their average costs and maximize their profitability in the long run.

Related terms

Economies of Scale: The reduction in average cost per unit that a company experiences as its scale of production increases, due to efficiencies and cost savings.

Optimal Scale of Production: The level of output at which a company can produce goods or services at the lowest possible average cost per unit.

Long-Run Average Cost Curve: A graph that shows how a company's average cost per unit changes as its scale of production increases in the long run.