Why are bigger versions of items often more economical?

Question

So for example I might I have 500g bottle of iced tea that’s $2.80 but then there’s a 1L version that’s $3.00

Why is that?

In: 1

Answer 1

Economy of scale. Let’s say I make and sell bottled tea. I need a factory, machinery, labor, and raw materials. Factory rent, and machinery are both good for 100 million bottles a year. Factory rent is $10,000 a month and buy the machinery for $12,000. These costs are fixed. What that means is I would have to pay that if I make one bottle of tea or a hundred million bottles of tea. Labor and raw materials depend on the number of bottles I make – the more bottles the more tea leaves I buy and the more employees I hire.

Now if I produce only 1 bottle a month I still need to pay the fixed costs and minimum amount for raw materials and labor. So I would price that bottle at $11,000 (factory rent + machine cost per month)+ whatever I paid for labor ($1000), and raw materials ($1,00)+ a little bit of profit($100). So I sell one bottle for $12,200 if I want to stay in business.

If I produce 100,000 bottles the pricing changes. Now my expenses are $11,000 (factory rent + machine cost per month)+ whatever I paid for labor ($25,000), and raw materials ($25,000)+ a little bit of profit. So now my expense per bottle is $0.61. I can add $0.39 as a profit and sell each bottle for $1. My profit would be $39,000.

Hope that explains it.