Economies of scale and minimum efficient scale

Economies of scale and MES

Economies of scale: falls in long-run average cost as the scale of output increases.

Minimum efficient scale (MES): the lowest output at which LRAC reaches its minimum. If MES is large relative to the size of the market, only a few firms can produce efficiently, so the industry tends to be an oligopoly or a natural monopoly. If MES is small, many firms can survive.

Internal economies of scale

Arise from the growth of the firm itself:

• Technical: larger, more efficient machines; specialisation; the 'law of increased dimensions' (doubling a container's sides more than doubles its volume).
• Financial: big firms borrow at lower interest rates and can issue shares.
• Managerial: specialist managers in finance, marketing and HR.
• Marketing: advertising costs spread over more units.
• Purchasing: bulk-buying discounts.
• Risk-bearing: diversification across products and markets.

External economies of scale

Arise from the growth of the industry in an area, and lower costs for all firms there:

• a pool of skilled labour trained by other firms and local colleges
• better transport links and infrastructure
• knowledge sharing, specialist suppliers and research centres nearby.

Diagram in words: internal economies are a movement down the firm's LRAC; external economies shift the whole LRAC curve downwards.

Exam tip

Name the specific type of economy and explain the mechanism with a chain: 'a larger supermarket buys in bulk, so it gains purchasing discounts, so its average cost falls, which allows lower prices'. A list of types without a chain stays in the lowest levels.

Worked example

A firm's total cost is $50,000 for 1,000 units and $80,000 for 2,000 units. Calculate the percentage change in average cost and say what it shows.

1. AC at 1,000 = $50; at 2,000 = $40.
2. % change = (40 - 50) / 50 x 100 = -20%.

Answer: AC falls by 20%: economies of scale.

Check yourself

1. Total cost rises from $120,000 to $180,000 when output rises from 10,000 to 20,000 units. Find the new average cost.
   Show answer

   $9. AC = 180,000 / 20,000 = $9.

2. Using those figures, find the percentage fall in average cost.
   Show answer

   25 %. AC falls from $12 to $9: (12 - 9) / 12 x 100 = 25%.

3. A large firm can borrow at a lower interest rate than a small firm. This is a
   • technical economy of scale
   • financial economy of scale
   • external economy of scale
   • diseconomy of scale
   Show answer

   financial economy of scale. Lenders see large firms as less risky.

4. Which is an external economy of scale?
   • A firm buys raw materials in bulk
   • A firm installs a larger machine
   • A local university trains workers in the skills an industry needs
   • A firm hires a specialist finance director
   Show answer

   A local university trains workers in the skills an industry needs. It comes from the industry and area, not the individual firm's size.

5. If the minimum efficient scale is large relative to market demand, the industry is likely to have
   • only a few firms
   • a very large number of small firms
   • no barriers to entry
   • perfectly elastic demand for each firm
   Show answer

   only a few firms. Only a few firms can each produce at MES and still sell their output.

6. On a diagram, an external economy of scale is shown as
   • a movement down the firm's LRAC curve
   • an upward shift of the AR curve
   • a downward shift of the firm's LRAC curve
   • a movement up the MC curve
   Show answer

   a downward shift of the firm's LRAC curve. External economies reduce costs at every output, shifting LRAC down.

7. Which is a technical economy of scale?
   • Using a larger, more efficient production line
   • Advertising on national television
   • Receiving bulk discounts
   • Spreading risk across several countries
   Show answer

   Using a larger, more efficient production line. Technical economies come from the production process itself.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (XEC11/YEC11), Unit 3 Business behaviour and Appendices 6 and 7

Last updated 8 November 2026. Spotted a mistake? Tell us.