Eli5 what is economy of scale and what is economy of scope?


Its 3 am and i dont have the brain activity to understand anything anymore. Please be as patronising as possible.

In: 23

An economy of scale is where, by going all-in on a single item/industry, you can be more efficient. Think about building huge factories that all make the same thing over and over again.

An economy of scope is the idea that, by diversifying your business, you can also be very efficient. For example, a gas station doesn’t only sell gas; they sell snacks, drinks, common car supplies, common medicines, and sometimes alcohol. By providing a wide variety of goods, they are attracting a wider customer base and therefore getting more business.

Economy of scale: once you’ve figured out *how* to make something predictably and reliably, as you make more and more, the dominating cost becomes the materials and labor (not the equipment or the engineering). So the overall cost per unit comes down as more are manufactured. Think of how much engineering goes into making a smartphone, and how much it would cost if they only made a few hundred!!

The example I love to give is disc brake pads. Cars and fancier bicycles both use them, they are similar materials and obviously cars use much beefier pads, but they are much closer in price than in size, because there are way, way more cars than bicycles with disc brakes.

Economy of scope is when you lower the price of production by making a lot of different things. For example using waste product from production of one product to make different product or using common infrastructure.

Economy of scale is when you lower the price of production by making more of it. There is a lot of fixed cost in making product like development and marketing,…

The word “economy” in these phrases means “savings.”

Economy of scale: it costs less to make something in bulk (and then divide it into small packages for sale) than to make many (small) quantities. A cookie-making factory will have less costs per cookie than, say, the sum of all the pastry chefs in NY working separately at their bakeries to make cookies.

Economy of scope: it costs less to make related items in a factory than to have separate factories for each item. The cookie factory could easily be expanded to also make waffles, pancakes, donuts, etc., and it would cost less than building separate factories for each of these related products.

Economy of scale has to do with automation.

I am using “hours” as a fungible resource. A hodge-podge of money/cost/manpower that covers all of those things (this is a vast simplification).

Previously if you wanted produce something, a single person would make it. It would take them an hour to make the first one and the second one and the third one.

Then came along automated factories.

Once the factory is running the amount of manpower needed to produce the same product is 1/1000 of a hour to produce each and every unit.

The issue is takes 10,000 hours to set up the factory (you have to spend those 10,000 hours).

So if you use the factory to produce 1 unit, that unit has cost you 10,000.001 hours to produce that unit.

If you produce 10 units, it has cost you 1,000.001 hours to produce each unit.

If you produce 10,000 units it costs you 1.001 hours to produce each unit.

If you produce 100,000 units is costs you 0.101 hours to produce each unit.

This is the economy of scale. The factory costs manpower (or money) to set up and get running. To make the factory cost competitive to the guy down the street that can make one unit an hour, the factory has to produce at more than 10,000 units (which will take you 10 hours to do) in order to sell at the same price as the guy down the street. As you produce more units, the total price to produce the units continues to go down.

And once you have paid off the cost of the factory, you can lower prices even more to just cover cost of manufacture.