How Do You Calculate Economies of Scale?
Learn how to calculate economies of scale by comparing average cost at two output levels, with a worked example and the key long-run distinction for exams.
Calculate average cost at two output levels and compare the results. If the firm expands in the long run and its average cost falls, it is experiencing economies of scale. A percentage fall can show how large the saving is.
For Cambridge International A Level Economics, this covers the relationship between economies of scale and decreasing average costs in Types of cost, revenue and profit, short-run and long-run production (7.5.5).
How to calculate it
Average cost is the cost of producing each unit of output:
Average cost=Total costOutput \text{Average cost} = \frac{\text{Total cost}}{\text{Output}} Average cost=OutputTotal costCalculate it once before expansion and again afterwards. To express the reduction as a percentage of the original average cost, use:
Percentage fall in average cost=Old average cost−New average costOld average cost×100% \text{Percentage fall in average cost} = \frac{\text{Old average cost} - \text{New average cost}}{\text{Old average cost}} \times 100\% Percentage fall in average cost=Old average costOld average cost−New average cost×100%Worked example
Suppose a firm produces 1,0001{,}0001,000 units at a total cost of 10,00010{,}00010,000 cost units. Its average cost is 101010 cost units per unit. After expanding, it produces 2,0002{,}0002,000 units at a total cost of 16,00016{,}00016,000 cost units. Its new average cost is 888 cost units per unit.
The cost per unit has fallen by 222 cost units. Dividing that fall by the original average cost gives a 20%20\%20% reduction. Notice that total cost rose because the firm produced more, even though each unit became cheaper to produce. That is why total cost alone cannot tell you whether economies of scale have occurred.
Check the time period
Economies of scale are a long-run concept: the firm can change all its factors of production, such as its equipment and workforce, as it expands. If output increases while some factors remain fixed, a fall in average cost may instead be a short-run effect. In an exam, calculate and compare average costs, but check that the question describes long-run expansion before calling the fall an economy of scale. Without that context, the calculation shows a lower average cost, not necessarily its cause.
