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What Are Economies Of Scope?

by gbaf mag

Economies of scope and economies of scales are two terms that describe why smaller companies often have lower prices than their larger competitors. A business that has economies of scope benefits because expenses are spread out over a much larger number of products. In this example, each unit sold is less expensive than if sold individually. A business that has economies of scales has a much lower cost of good sold because larger units tend to be manufactured in greater quantities and put out lower prices.

How can a company benefit from economies of scope? If a company manufactures goods that are less expensive or even free, they will typically see their bottom line increase. However, they may not see an increase in sales because the number of units that sell for less than the price of the average unit sold is fewer.

Examples of goods that can be manufactured with economies of scope include: raw materials like steel, concrete, aluminum, and other building and material commodities, parts and components, and engineering or design services. An engineering school will be able to help graduates find jobs in these sectors. These types of companies benefit from economies of scope because there is a smaller number of companies that specialize in the specific goods that they provide.

On the flip side, when a firm specializes in producing specific products, they are at a severe disadvantage. They lose economies of scope because there are fewer buyers for their inputs. For example, there is only one manufacturer of tires, and only five tire makers need to make tires from scratch. If the owner of such a business specialized in producing only tires, the firm would have to expand its production processes significantly in order to compete with other tire producers.

Another example of how production efficiency can be boosted by economies of scope is when firms take on new production processes that can lower their fixed costs per unit. The most common example is when firms move from manual to automated assembly lines. By making the process more efficient, firms gain an immediate cost advantage because they no longer have to pay the high cost of employing highly skilled labor. This leads to better profits as well as lower operating expenses. As more firms move toward automated assembly lines, economies of scope can expand because more of them will be able to produce goods that consumers want at a reduced cost.

One example of how production efficiency can benefit firms occurs when firms specialize in particular market segments. If an automobile firm specializes in producing SUVs, then it stands to reason that the company stands to benefit from economies of scope because it will be less expensive to produce SUVs than other brands of cars. This allows the firm to sell more SUVs, and therefore, more SUVs lead to more sales. The result is that firms with markets with plenty of demand can gain economies of scope by expanding their product line.

Finally, when firms take on too many types of business activity, economies of scope can occur because there are simply too many sources of product demand. Suppose, for example, that a firm specializes in manufacturing tools. Now, suppose that it takes on too much debt to support its production costs. Now, the firm has two options: It can either diversify into other types of tools (such as plumbing or electrical) or it can move all of its manufacturing to places where those types of tools are not available (such as Asia).

Although this seems like an extreme example, it highlights how diversification can lead to enormous economies of scope. The important thing to keep in mind is that all economic concepts – production, demand, diversification and savings – are interrelated. That is, economies of scope can arise when firms make additional investments in other areas. When the firm gets involved in another industry, it stands to reason that its costs of production go down, because the firm now stands to make a profit in the new area. Diversification can further lead to economies of scope by increasing the country’s comparative advantage.

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