what exactly are economies of scale? how do they come about, and what do they do exactly?

Question

what exactly are economies of scale? how do they come about, and what do they do exactly?

In: Economics

Answer 1

Imagine that you start a lemonade stand today in a busy commercial area. You pay the city $100 in rent to be at that location with really good traffic.

That $100 is a fixed cost; regardless of how many lemonades you sell, you pay the same amount of money to the city.

Now assume you sell lemonades for $2 and the ingredients for the lemonade cost you $1. You’re making a $1 profit on every lemonade, right?

Wrong. If you sell 10 lemonades that month, you lose $90; $10 gross profit – $100 rent.

If you sell 100 lemonades, you break even.

If you sell 1000, you make a healthy $900 profit.

That’s how economies of scale work.

Now you have to assume these economies of scale work across the entire supply chain. In a bigger company, there are more types of costs and more types of savings too. And your suppliers have the same opportunities to scale.