May 14, 2024; most recent update March 30, 2026

Table of Contents

1. Essence & Who It Advantages

2. Variable vs Fixed Costs

3. Production

4. Storage

5. Transport

6. Buying

7. Diseconomies of Scale

    a. Production: Inputs Increasing Faster Than Output

    b. Storage: Wasted Space & Greater Difficulty

    c. Transport: Limited Capacity

    d. Buying: Less Than Ideal Situation

8. Economies of Scale in Combination

Economies of scale is a situation when increasing the number of units produced, bought, transported, or stored decreases the cost per unit of those actions respectively. It is a phenomenon most closely associated with businesses as they expand the size of their operations.

A "unit" or "item" refers not just to individual items that are clearly physically separate from others but also raw, sellable quantities (pound, quart, ton, etc). So, for example, when a business has more raw quantity (e.g. more tonnage) to sell, it also has more units (tons) to sell. Sellable quantities can also be a money amount, such as the coverage of an insurance policy. Thus when someone buys a larger insurance policy, they buy more units from the insurer. In that case, each unit is a dollar, pound, peso, or whatever currency is being used in the transaction.

Larger, wealthier businesses can usually achieve economies of scale to a greater degree. This is a main reason why they generally have lower per unit prices than smaller businesses.

Two kinds of costs are important in economies of scale: variable and fixed costs.

Variable costs are costs that vary according to the number of units involved. Obviously, the more units that are produced, stored, or transported, the higher the overall cost will be. Higher production involves at least more material. More stored units requires a larger building, at least when space is being fully utilized, and usually more labor. More units transported equals, at minimum, more fuel.

Fixed costs stay the same regardless of the number of units produced, stored, or transported. A flat daily or monthly fee for renting equipment would be an example.

There can also be costs that are neither fixed nor depend on the number of units involved, but those don't help us understand what's happening during economies of scale.

Variable and fixed costs don't apply to buying-based economies of scale. It is a different animal from the others.

The clearest examples of economies of scale involve production. The traditional definition of economies of scale pertains only to production. (But clearly the general concept applies to more activities than just that, which is why broader definitions exist.)

When economies of scale happens in this context, oftentimes output increases faster than inputs. For example, suppose 10 workers produce 30 units a day. If the business hires 10 more workers and 80 units are produced a day, then economies of scale is occurring. The average productivity per worker goes from 3 units daily to 4.

In that example, the increased output relative to input is what allows the production cost per unit to decrease. If each worker costs $100 a day, then total labor costs $1000 a day in the first situation. At 30 units a day, that means each unit costs $33.33 in labor ($1000/30 units). In the second situation, total labor costs $2000 a day. But when divided by the 80 units of production, each unit costs $25 in labor.

What causes output to increase faster than inputs is added physical or psychological efficiencies: the increased inputs make it easier physically or psychologically to do at least one of the tasks involved in production. This means less physical resources or time to do one or more of the tasks and thus, all other factors remaining the same, less cost per unit. Therefore, not only does overall production expand from the increased inputs, but each unit of production becomes cheaper.

Specifically, some examples are less physical strain per worker the more workers there are to lift or push equipment or production items; each worker reducing their number of production tasks due to more workers, thereby wasting less time going back and forth between different tasks; and when more assembly lines not only increase production but reduce or eliminate previous bottlenecks.

However, economies of scale can still exist even if increased efficiency doesn't occur. Taking a closer look at the previous example can help us understand why. The extra cost of increased labor was more than compensated for by the disproportionate increase in productivity -- again, output increased faster than inputs. But how exactly did that lower the cost per unit? It's that, in the second situation, the total cost of labor was divided by proportionately more units. Thus, because each unit represented a smaller fraction of total labor costs than before, each unit cost less in labor.

The same thing can happen when efficiency stays the same, if the business  has fixed costs. (costs that remain static over a certain time period and are therefore not connected to production volume).

Suppose management keeps everything the same but rather than increase the number of workers, each worker's shift goes from 8 to 10 hours. And the  result is simply that worker efficiency (output per worker) is unchanged, thus total output increases 25%. The increased total volume will itself lower per unit costs since it will necessarily divide fixed costs by proportionately more units -- if the business has fixed costs, which most do.

Perhaps the business produces food and one fixed cost is for the robotic cleaning of equipment after each shift, costing exactly $100 each time. If production per shift increases, then it means that the $100 cleaning cost per shift is divided by more units per shift and thus that per unit cost decreases. For instance, if 100 units are made per shift, then it costs $1 per unit to clean the equipment. But if production increases 25%, to 125 units, then the cleaning cost per unit falls to $.80 ($100/125).

It is different, yet it's essentially what happened in the first example and what all cost savings in economies of scale are based on: at least one cost (whether fixed or variable) is divided by proportionately more units than before. That's really the fundamental cause of most instances of economies of scale. The other causes simply explain how or why it happens when unit quantity increases. (But, as you'll see, buying-based economies of scale is different from the other forms and has a unique cause.)

Finally, even though increased production doesn't necessarily lead to increased efficiency and thus lower per unit variable costs, oftentimes it does since certain factors involved tend to assist each other towards those ends. For example, a company might increase volume by increasing production speed (output per time period) through a simpler product design. And in doing so, often it reduces the per unit cost through not only through quicker production but fewer product parts. But even when increased volume is the sole focus, speed tends to increase anyway. When a larger factory is made in order to generate more production, the greater number and/or size of assembly lines allows for more workstations per assembly line. This means on average fewer tasks per worker and thus less time is wasted by workers going back and forth between different tasks.

Hence the term "economies of scale."

First, when it comes to buildings, storage pertains to more than just warehouses and the like, but to stores and factories as well: larger stores can store more items, and larger factories can store and produce more items. So, in this general sense, a store or factory is to some extent a "storage building" too.

Storing more items than fewer can be more cost effective when a storage building is larger. All other things being equal, a larger storage building has proportionately more space inside relative to the materials of the building. This is because it has a smaller surface to volume ratio. Thus in the long run a larger storage building can generate more "output" (revenue) relative to "input" (construction, maintenance, and operation costs) since it can store or produce proportionately more units, which are the means of the owner's revenue either in terms of potential sales or renters using the space. In other words, generally it's cheaper per unit when items are stored and/or produced in a larger building -- at least when the building is used to full capacity.

For the same physical reason, larger boxes, containers, and packages are usually cheaper per unit of space received. In addition to buying-based economies of scale (below), this is one of the reasons that larger quantities (units) of a good are usually a better value than smaller quantities.

It is cheaper per unit to transport items in bigger ships, trucks, etc than smaller ones. These bigger vessels allow more items to be transported per shipment. Clearly there is a storage factor that partly explains why larger vessels are usually more cost effective for businesses able to sell the larger volume. But it also has to do with fuel and labor. Even though a larger shipment contains more items and therefore requires more fuel, this is still cheaper per unit than transporting the same volume of items through a larger number of shipments. More shipments equate to not only more fuel overall but more time, which increases the per unit cost of labor. So, whether it be a shipping company or a business that ships its own products, the per unit cost advantage of transport from larger ships, etc means a higher profit margin per unit. It also allows such businesses to offer lower per unit prices for their products or services, all other factors being equal.

Frequently sellers, whether of tangible or intangible goods, will offer buyers a better per unit price with a larger purchase since this means more profit for the seller. This is often seen at the store, when larger packages, cans, bottles, etc are a better value than smaller ones or the store offers a lower per item price if you buy a certain quantity of those items. For the same reason, insurers will often give a better value with a more expensive insurance package: the policy has a greater amount of coverage per dollar that you spend on it.

Producers can save money per unit by buying inputs in larger quantities from  other producers or middleman, just as middlemen can get each unit at a cheaper price by making larger purchases from producers or other middlemen.

Diseconomies of scale is a situation when increasing the number of units produced, bought, transported, or stored increases the cost per unit of those actions respectively. Since fixed costs divided by more units would necessarily decrease each fixed cost per unit, then it's clear that diseconomies of scale happens because variable costs (overall) are divided by proportionally fewer units than before. At least that is true regarding production, storage, and transport. But, once again, buying can have its own unique causes, just as it does in economies of scale. 

Increased input can lead to a relative decrease in output and thus raise the per unit cost of production. Added physical or psychological inefficiencies are the causes. Some examples are cramped space that slows workers and increased volume causing machines to break down more frequently.

Storing more units can require at least one more storage building, thus increasing the per unit costs of storing than with storing fewer items. If the extra storage building is underutilized, with not enough units inside to financially compensate for the building's construction, maintenance, or operating costs, then the business's inputs increase relative to output and thus per unit storage costs increase. This is especially true if the extra storage building is of a larger size rather than smaller.

As for individual buildings, a larger building can be less cost effective than a smaller one. When a building reaches a certain size, logistics become significantly more complicated. It becomes much harder to stock, locate, and retrieve units without more expensive and advanced equipment and technology. This can be more expensive per unit stored if the building is underutilized.

Transporting more goods isn't always more cost effective. For example, a single truck might be able to deliver 10 items for you, but 11 items might require a second truck and thus cost more per item than the smaller shipment.

Normally it's in a seller's interest to offer a lower per unit price if the buyer purchases a larger quantity. Therefore when buying a larger quantity increases the per unit price, it's usually because of diseconomies of scale elsewhere: with transport and/or storage.

But there can be any number of circumstances when, for a different reason, a seller might charge a higher per unit price for a larger purchase. Perhaps a product's smaller packages or containers are overstocked or not selling, so the seller puts them on clearance or closeout. Also, a business might determine that a larger purchase puts proportionately more strain on their production or shipping equipment, thus warranting a higher per unit price to compensate for the wear and tear. This only scratches the surface for why a seller might have such a pricing system and transport or storage diseconomies of scale aren't the cause. But in most of these (uncommon) cases there is likely some less than ideal issue at hand. In the first example, above, the seller has a less than ideal inventory situation; in the second, the business would likely have subpar production or shipping equipment that can barely handle larger purchases.

Often one or more types of economies of scale are combined in the same transaction. For example, a middleman might initially benefit from the producer lowering the product's per unit price due to production efficiencies. The producer will also sell those goods at an even lower per unit price if they are bought in larger quantities, since that helps their bottom line. Also, part of the reason the producer can sell those at a lower per unit price is because shipping them in large quantities is cheaper on a per unit basis. For all of those reasons, the middleman can then sell those items to the customer at a lower per unit price, especially if the customer buys in larger quantities. Thus, at least in many cases, the final per unit price the customer pays is the result of several layers of economies of scale.