Economies of Scale: Meaning, Types, Benefits and Examples

Introduction

Imagine two bakeries making bread. One small bakery makes 100 loaves each day. A large bakery makes 10,000 loaves.

The large bakery may buy flour at a lower price, use bigger machines and spread its rent and equipment costs across more loaves. As a result, each loaf may cost less to make.

This is a simple example of economies of scale.

Economies of scale happen when a business increases its production and its average cost per item falls. In simple terms, making more products can make each product cheaper to produce.

This idea helps explain why many businesses grow, invest in larger equipment and serve more customers. However, becoming bigger does not always make a business better. If a company grows too much, its costs may rise again.

In this guide, you will learn how economies of scale work, their main types, real business examples, their benefits and the problems that can come with business growth.

What Are Economies of Scale?

Economies of scale are the cost savings a business can gain when it increases the amount it produces.

As production grows, the average cost of making each product can fall. This means a business may spend more money overall but pay less to make each item.

Average cost means the cost of producing one unit. It is worked out by dividing total production costs by the number of units made.

For example, imagine a small business spends £1,000 to make 100 chairs.

Its average cost is:

£1,000 ÷ 100 = £10 per chair.

Now imagine the business grows and spends £4,000 to make 500 chairs.

Its average cost becomes:

£4,000 ÷ 500 = £8 per chair.

The total cost has increased from £1,000 to £4,000. However, the cost of making each chair has fallen from £10 to £8.

That is an economy of scale.

A Simple Everyday Example

Think about buying a large pack of bottled water.

A single bottle may cost £1. A pack of 12 may cost £9. This means each bottle in the pack costs 75p.

The shop may receive a lower price because it buys a larger amount from its supplier. It can then pass some of that saving to customers.

Businesses can gain similar savings when they buy materials, produce goods or deliver services on a larger scale.

Important: Economies of scale do not mean that total costs must fall. Total costs often rise as production increases. The key point is that the average cost per unit falls.

How Do Economies of Scale Work?

Economies of scale work because a growing business can use its resources in a more efficient way.

It may have more money to invest in equipment, employ skilled workers, buy materials in bulk and improve its production process.

For example, a small clothing company may use simple sewing machines and make 200 shirts each week. As demand grows, it may buy faster machines and organise workers into specialist roles.

This can help the company make more shirts without increasing costs at the same rate.

A Simple Numerical Example

Consider a business that makes wooden tables.

Number of tables	Total cost	Average cost per table
100	£2,000	£20
200	£3,600	£18
400	£6,400	£16
800	£11,200	£14

The table shows that total costs rise as the business makes more tables. However, average cost falls from £20 to £14.

This happens because the business spreads some costs across more products and may use its resources more efficiently.

Why Can Producing More Reduce Costs?

There are several reasons:

• Better use of equipment: Machines can produce more goods during the same period.
• Bulk buying: Suppliers may offer lower prices for larger orders.
• Specialist workers: Employees can focus on tasks they perform well.
• Lower cost per delivery: A full lorry may carry more products at a lower transport cost per item.
• Shared costs: Rent, advertising and some management costs can be spread across more sales.

The exact savings depend on the type of business and how well it manages its growth.

Types of Economies of Scale

There are two main types of economies of scale:

1. Internal economies of scale.
2. External economies of scale.

Internal economies come from the growth of one business. External economies happen when the whole industry grows and businesses in that industry gain shared benefits.

Internal Economies of Scale

Internal economies of scale are cost savings that a business gains from its own growth.

A company does not need the whole industry to grow. It can gain these savings by increasing its own production and improving the way it works.

There are six common types of internal economies of scale.

1. Purchasing Economies

Purchasing economies happen when a business buys materials or products in large amounts and receives a lower price.

Suppliers may offer discounts because large orders can help them sell more goods at once.

Example:

A small café buys 10 bags of coffee each week. A large café chain buys 10,000 bags from a supplier.

The supplier may offer the larger buyer a lower price per bag.

This helps the chain reduce its average buying cost. It may then improve its profit margin or offer more competitive prices.

2. Technical Economies

Technical economies happen when a business uses better machinery, technology or production systems to lower its cost per item.

Large businesses may have enough money to invest in equipment that smaller firms cannot afford.

Example:

A small food producer may pack products by hand. A large food company may use an automatic packing machine.

The machine can pack many products quickly and may reduce the need for some manual tasks. Its purchase and running costs can be spread across a large number of products.

This can lower the average production cost.

3. Financial Economies

Financial economies happen when larger businesses can access finance on better terms.

Banks and other lenders may see established companies as lower-risk borrowers if they have a strong record, steady income and valuable assets.

This may help them obtain loans at lower interest rates or with more suitable terms.

Example:

A large supermarket chain wants to build a new distribution centre. It may be able to secure a large business loan on better terms than a new, small retailer.

Lower borrowing costs can reduce the cost of expansion.

However, finance is not always cheaper for a large company. Lenders still consider its debt, cash flow and financial health.

4. Managerial Economies

Managerial economies happen when a growing business can employ specialist managers and professionals.

A small business owner may handle sales, accounts, marketing and staff management alone. A larger company can employ people with skills in each area.

Example:

A growing clothing company may hire a finance manager, marketing manager and operations manager.

Each person can focus on a specific task. This may improve planning, reduce mistakes and make the business more efficient.

5. Marketing Economies

Marketing economies happen when a business spreads its advertising and promotion costs across more products or sales.

A large company may run one advertising campaign that promotes a product sold in hundreds of shops.

Example:

A national supermarket chain pays for a television advert. The advert promotes products sold across many branches.

The cost of the campaign is shared across a large number of stores and sales.

A small shop may not have the same budget or reach. It may need to spend more per sale to reach a similar number of customers.

6. Risk-Bearing Economies

Risk-bearing economies happen when a large business can spread risk across different products, services or markets.

If one product performs poorly, income from other products may help support the business.

Example:

A company sells clothing, shoes and sports equipment. If clothing sales fall during one season, its other product lines may help maintain income.

A business that depends on only one product may face greater risk if customer demand changes.

Diversification does not remove risk, but it can help a business manage it.

External Economies of Scale

External economies of scale happen when the growth of an industry helps several businesses in that industry lower their costs.

These savings do not come only from one company’s expansion. They come from improvements in the wider industry or the area where businesses operate.

For example, when many technology companies set up in one area, the area may attract skilled workers, specialist suppliers and better transport links.

Several companies can then benefit from these improvements.

Common examples include:

1. Access to Skilled Workers

When an industry grows, more people may train for jobs in that field.

Businesses can find workers with the skills they need without having to train every employee from the beginning.

Example: A large group of engineering companies in one area may attract more trained engineers and technicians.

2. Better Transport and Infrastructure

Industry growth can encourage investment in roads, railways, ports and other facilities.

Better transport can help businesses move materials and products more quickly.

Example: A growing manufacturing area may benefit from improved road links and nearby freight services.

3. More Specialist Suppliers

As an industry grows, specialist suppliers may open businesses nearby.

Companies can then buy parts, tools and services from local suppliers instead of bringing everything from far away.

Example: A region with many car manufacturers may attract businesses that supply vehicle parts and specialist equipment.

4. Shared Knowledge and Business Services

Businesses in the same industry may benefit from training centres, research groups and specialist professional services.

New ideas and knowledge can spread between workers, suppliers and other organisations.

Example: Technology companies in a large business cluster may benefit from nearby training providers and research organisations.

5. Industry Clusters and Local Networks

An industry cluster is an area where many related businesses operate close to one another.

These businesses may share access to workers, suppliers, transport and knowledge.

Example: London’s financial district brings together banks, financial firms and professional service providers. Their presence can support a wider network of business services.

Internal vs External Economies of Scale

Internal economies	External economies
Come from one firm’s growth	Come from industry growth
Mainly benefit the growing firm	Can benefit many firms
May involve better machines or bulk buying	May involve skilled workers or better roads
Depend on the firm’s own decisions	Often depend on wider industry development

The main difference is simple: internal economies come from growing one business, while external economies come from improvements in the wider industry.

Real-Life Examples of Economies of Scale

Economies of scale can be seen in many industries. Large supermarkets, manufacturers and online retailers often operate at a scale that allows them to spread costs across large numbers of products and customers.

The examples below show how the economic idea can work. They do not claim that a company has achieved a specific saving unless that figure is supported by published evidence.

1. Tesco and Large-Scale Retailing

Tesco is one of the UK’s major supermarket businesses.

Its 2026 annual report highlights its large store network, online reach, supplier relationships and supply chain. These features show how a large retailer can operate across many locations and serve a wide customer base.

A retailer with a large network may be able to:

• Place large orders with suppliers.
• Spread advertising costs across many stores.
• Use distribution systems to supply several locations.
• Invest in technology and supply chain improvements.

These are ways in which large-scale retailing can support economies of scale.

The size of a business alone does not prove that every product is cheaper. Actual savings depend on buying terms, operating costs and how well the company manages its network.

2. Large Car Manufacturers

Car production often needs expensive factories, machinery and specialist equipment.

A manufacturer that produces a large number of vehicles may spread the cost of its factory, design systems and production equipment across more cars.

Automation can also help factories complete repeated tasks at speed and with consistent results.

For example, a car factory may use robotic equipment for welding and painting. The cost of this equipment is high, but it may become more affordable per car when production is large enough.

This is an example of how technical economies can support large-scale manufacturing.

3. Amazon and Distribution Networks

Amazon operates a large network of fulfilment centres and other facilities.

Its annual reports describe investment in fulfilment, technology and infrastructure. These facilities help the company store, process and deliver orders across its markets.

A large distribution network can support economies of scale through:

• Shared storage facilities.
• Large volumes of deliveries.
• Technology used across many orders.
• More organised stock and delivery systems.

However, a large network also brings high costs. Buildings, workers, transport and technology all need investment.

A company must manage these costs well to gain the full benefit of its scale.

4. Large Supermarket Chains and Advertising

A supermarket chain may promote its products through national advertising.

One campaign can reach customers across many stores. This means the advertising cost can be spread across a large number of sales.

A small independent shop may need to rely on local advertising. It may have a smaller budget and reach fewer customers.

This shows how marketing economies can give larger retailers a cost advantage.

Benefits of Economies of Scale

Economies of scale can help businesses become more efficient and compete in their markets.

The main benefits include:

1. Lower Average Production Costs

This is the main benefit.

When the average cost of making each product falls, a business may have more room to set competitive prices or improve its profit margin.

2. Better Use of Resources

A larger business may use its machines, staff, buildings and transport more efficiently.

For example, a factory can make better use of expensive equipment when it produces enough goods to keep the machines busy.

3. Improved Productivity

Specialist workers and better production systems can help employees complete tasks more quickly.

This may increase the number of products made in a given period.

4. Potentially Lower Prices for Customers

If a business reduces its average costs, it may choose to pass some of the savings to customers through lower prices.

This can make products more affordable.

However, lower costs do not guarantee lower selling prices. A company may keep prices the same and use the saving to improve its profit margin.

5. Higher Profit Margins

If selling prices stay the same while average costs fall, the business may earn more from each product.

This can improve its profit margin, provided other costs and sales conditions do not change in a way that removes the saving.

6. Stronger Competitive Position

A business with lower costs may be able to compete more effectively with other companies.

It may have more room to adjust prices, invest in better products or offer improved services.

7. More Investment in Technology and Innovation

Larger businesses may have more resources to invest in research, new equipment and better systems.

These investments can improve productivity and help the company develop new products.

Remember: Economies of scale create the chance to improve costs and profits. They do not guarantee business success. Demand, competition, wages, materials and management still matter.

Diseconomies of Scale: When Businesses Grow Too Large

Diseconomies of scale happen when a business grows so much that its average cost starts to rise.

In the early stages of growth, a company may gain savings from better equipment, bulk buying and specialist workers.

But after reaching a certain size, managing the business can become harder. Communication may slow down, decisions may take longer and different teams may struggle to work together.

These problems can increase the cost of producing each item.

Main Causes of Diseconomies of Scale

1. Communication Problems

A small business may have a simple management structure. Workers can speak directly to the owner or manager.

A large company may have many departments and levels of management. Important information can take longer to reach the right people.

This can lead to mistakes and delays.

2. Slow Decision-Making

Large companies often need approval from several managers before making important decisions.

This can make it harder to respond quickly to changes in customer demand or market conditions.

3. Management Complexity

Managing many workers, branches and departments can be difficult.

A company may need more managers and support staff. If these roles are not organised well, management costs can rise.

4. Coordination Problems

Different teams may have different goals or ways of working.

For example, a sales team may promise customers quick delivery, while the production team may not have enough stock ready.

Poor coordination can cause delays, waste and extra costs.

5. Lower Employee Motivation

Workers in a very large business may feel less connected to the company.

They may have fewer chances to share ideas or take part in decisions. This can reduce motivation and productivity.

A Simple Example

Imagine a family-owned bakery that grows into a chain with 100 branches.

At first, the owner can speak with every branch manager. As the company grows, it needs regional managers, head office teams and more reporting systems.

If communication becomes poor, branches may order the wrong stock or waste ingredients.

The business may then spend more money fixing problems. Its average cost could rise.

This is a possible example of diseconomies of scale.

Economies of Scale vs Diseconomies of Scale

Both ideas explain how average costs can change as a business grows.

However, they describe different results.

Point	Economies of scale	Diseconomies of scale
Meaning	Growth lowers average cost	Growth raises average cost
Average cost	Falls	Rises
Effect of growth	Makes production more efficient	Can make management and production less efficient
Main causes	Bulk buying, better machines and specialist workers	Poor communication, complex management and coordination problems
Possible result	Better cost control and stronger competition	Higher unit costs and lower efficiency

A business may experience economies of scale as it grows and later face diseconomies if it becomes too large or poorly managed.

Understanding the Long-Run Average Cost (LRAC) Curve

The long-run average cost curve, often called the LRAC curve, shows how the average cost of production changes when a business can change its scale of operation.

In the long run, a business has time to change all its resources. It can move to a larger factory, buy new machines, employ more workers or change its production methods.

The LRAC curve helps explain three possible stages:

1. Economies of scale.
2. Constant returns to scale.
3. Diseconomies of scale.

1. The Downward Section: Economies of Scale

At first, the LRAC curve slopes downwards.

This means average cost falls as output increases.

The business may gain from bulk buying, better machinery, specialist workers and spreading fixed costs across more products.

2. The Flat Section: Constant Returns to Scale

After a certain point, average cost may stop falling.

This is called constant returns to scale.

The business can increase production without changing its average cost by much.

For example, if output doubles and the total cost also doubles, the average cost stays the same.

3. The Upward Section: Diseconomies of Scale

If the business grows beyond an efficient size, average cost may begin to rise.

The company may face more complex management, slower communication and coordination problems.

These issues can make each unit more expensive to produce.

LRAC Curve: Simple Diagram Concept

The following diagram shows the traditional U-shaped LRAC curve:

Average cost
     |
     |  \
     |   \
     |    \                 /
     |     \_______________/
     |
     +-------------------------------- Output
          Economies       Diseconomies
          of scale        of scale
                 |
           Minimum efficient
                 scale

How to read the diagram:

• The vertical axis shows average cost per unit.
• The horizontal axis shows the level of output.
• The downward section shows economies of scale.
• The flat section shows a period where average costs change very little.
• The upward section shows diseconomies of scale.
• The lowest point or lowest-cost range is linked to minimum efficient scale.

This is a simplified teaching diagram. In real markets, the LRAC curve does not always form a neat U shape. Some firms may have a curve that falls and then stays nearly flat.

What Is Minimum Efficient Scale (MES)?

Minimum efficient scale, or MES, is the lowest level of output at which a business can achieve the lowest long-run average cost.

In simple words, it is the smallest production level needed to gain the main cost benefits of operating at an efficient scale.

For example, imagine a factory reaches its lowest average cost when it makes 50,000 products each year.

If it makes fewer products, its average cost may be higher because it cannot spread its costs across enough units.

If it makes more, its average cost may stay close to the same level, at least for a time.

The MES matters because it can affect competition. If a business needs a very large level of production to reach low costs, new and smaller firms may find it hard to compete.

Economies of Scale and Diminishing Returns: Are They the Same?

No. These are different economic ideas.

Economies of scale are a long-run concept. They look at what happens to average costs when a business changes its overall scale of production.

Diminishing returns are usually a short-run concept. They happen when a business adds more of one input, such as workers, while another input, such as factory space, stays fixed.

For example, adding workers to a factory may increase output at first. But if the factory becomes crowded, each extra worker may add less output than the worker before.

The key difference is that economies of scale allow a business to change all its inputs over time. Diminishing returns look at the effect of changing some inputs while at least one remains fixed.

Economies of Scale in Different Industries

Economies of scale can happen in many industries, but the reasons and size of the savings are not always the same.

1. Manufacturing

Manufacturing businesses make products in factories.

They may gain economies of scale by using large machines, automated production lines and specialist workers.

For example, a factory making household appliances may spread the cost of its machines across thousands of products.

However, expensive equipment needs enough demand to make the investment worthwhile.

2. Retail and Supermarkets

Large retailers can order products in bulk and supply many shops from shared distribution centres.

They may also spread advertising and technology costs across a large number of stores.

A supermarket chain can use the same stock systems, payment technology and marketing plans across many branches.

3. Technology

Technology businesses may serve many users without increasing every cost at the same rate.

For example, once a software product has been developed, the company may be able to provide access to more users without building a completely new product for each customer.

However, serving more users still creates costs. The company may need more servers, security systems, customer support and technical staff.

4. Transport and Logistics

Transport companies may reduce their average cost by carrying more goods in each vehicle.

A lorry carrying a full load can move more products than one carrying only a few items.

Large logistics companies may also use central warehouses, route-planning software and shared delivery networks.

This can help them manage deliveries more efficiently.

5. Food Production

Food producers may buy ingredients in large amounts and use machines to prepare, pack and label products.

For example, a large food factory may use automated equipment to pack thousands of products.

This can reduce the average cost of packing each item.

However, food businesses must also manage storage, freshness, safety and waste. Producing more than customers need can increase costs instead of reducing them.

Are Economies of Scale Always Good?

No. Business growth can create benefits, but it can also bring new problems.

A company should not grow only because it wants to become bigger. It should consider whether more production will improve its costs, quality and ability to serve customers.

1. High Initial Investment

Larger factories, machines, warehouses and technology systems can cost a lot of money.

A business may need to borrow money or use its savings to pay for expansion.

If sales do not grow as expected, the investment may become a financial burden.

2. Greater Management Complexity

A business with many branches and workers can be harder to manage.

It may need more managers, systems and support teams. These extra costs can reduce the savings gained from growth.

3. Risk of Waste and Overproduction

Producing more goods does not mean customers will buy them.

If demand is lower than expected, a business may be left with unsold stock. Some products may need to be stored, discounted or thrown away.

This can damage profits.

4. Less Flexibility

A small business may be able to change its products or services quickly.

A large company may have more systems and people involved in each decision. This can make change slower and more costly.

5. Communication Problems

As a company grows, information may need to pass through several teams and managers.

If communication is poor, workers may receive unclear instructions or important details may be missed.

6. Risk of Diseconomies of Scale

If the cost of managing growth becomes greater than the savings from higher production, average costs may rise.

This is why businesses need to plan their growth carefully.

The best business size depends on the industry, customer demand, available resources and quality of management. A larger business is not always more efficient than a smaller one.

Frequently Asked Questions About Economies of Scale

1. What Are Economies of Scale in Simple Terms?

Economies of scale happen when a business produces more goods or services and the average cost of each unit falls. This may happen through bulk buying, better machines, specialist workers or shared costs.

2. What Is a Real-Life Example of Economies of Scale?

A large supermarket chain may buy products in bulk and supply many stores through a shared distribution network. This can reduce buying and delivery costs per item.

3. What Are the Two Main Types of Economies of Scale?

The two main types are internal economies of scale and external economies of scale. Internal economies come from one firm’s growth. External economies come from the growth of the wider industry.

4. What Is the Difference Between Internal and External Economies of Scale?

Internal economies benefit a business because it grows and improves its own operations. External economies happen when industry growth creates benefits that several businesses can share, such as better transport or more skilled workers.

5. What Are the Six Types of Internal Economies of Scale?

The six common types are:

1. Purchasing economies.
2. Technical economies.
3. Financial economies.
4. Managerial economies.
5. Marketing economies.
6. Risk-bearing economies.

Each type can help a business reduce its average costs as it grows.

6. What Are Diseconomies of Scale?

Diseconomies of scale happen when a business grows so large that its average cost starts to rise. Poor communication, slow decisions and management problems can cause this.

7. How Do Economies of Scale Reduce Average Costs?

They help a business use resources more efficiently. A company may buy materials at lower prices, use machines more effectively and spread costs across more products.

8. What Is the Long-Run Average Cost Curve?

The long-run average cost curve shows the lowest average cost a business can achieve at different levels of output when it has time to change all its production resources.

9. What Is Minimum Efficient Scale?

Minimum efficient scale is the lowest level of production at which a business can achieve its lowest long-run average cost.

10. Are Economies of Scale Always Beneficial?

No. Growth can bring high investment costs, complex management, waste and communication problems. If these problems become too large, a business may face diseconomies of scale.

11. How Do Economies of Scale Benefit Consumers?

Businesses may pass some of their cost savings to customers through lower prices. They may also use the savings to improve products, services or delivery. However, lower prices are not guaranteed.

12. Can Small Businesses Benefit from Economies of Scale?

Yes. A small business can gain some savings by buying materials in bulk, sharing services with other firms, using efficient technology or joining a business network. It does not need to become a large company to improve its costs.

Conclusion

Economies of scale explain why producing more can help a business lower its average cost per product. A growing company may gain from bulk buying, better machines, specialist workers and shared costs.

There are two main types. Internal economies come from the growth of one business, while external economies come from the growth of the wider industry.

However, bigger is not always better. A company may face higher costs if it becomes too difficult to manage. Poor communication, slow decisions and waste can lead to diseconomies of scale.

The main lesson is that successful business growth is about finding the right size, not simply becoming the biggest. A business should grow at a pace that allows it to control costs, meet customer demand and work efficiently.