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“Economies of scale” is a simple concept that can be demonstrated through an example. Assume you are a small business owner and are considering printing a marketing brochure. The printer quotes a price of $5,000 for 500 brochures, and $10,000 for 2,500 copies. While 500 brochures will cost you $10 per brochure, 2,500 will only cost you $4 per brochure. In this case, the printer is passing on part of the cost advantage of printing a larger number of brochures to you. This cost advantage arises because the printer has the same initial set-up cost regardless of whether the number of brochures printed is 500 or 2,500. Once these costs are covered, there is only a marginal extra cost for printing each additional brochure.
Economies of scale can arise in several areas within a large enterprise. While the benefits of this concept in areas such as production and purchasing are obvious, economies of scale can also impact areas like finance. For example, the largest companies often have a lower cost of capital than small firms because they can borrow at lower interest rates. As a result, economies of scale are often cited as a major rationale when two companies announce a merger or takeover.
However, there is a finite upper limit to how large an organization can grow to achieve economies of scale. After reaching a certain size, it becomes increasingly expensive to manage a gigantic organization for a number of reasons, including its complexity, bureaucratic nature and operating inefficiencies. This undesirable phenomenon is referred to as "diseconomies of scale".
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