Economies of scope: what are they?
An economic concept known as “economies of scope” describes how producing a variety of goods together rather than separately lowers the overall cost of production.
Formula for Economies of Scope
Where:
C(qa) represents the cost of producing good a in the amount of qa separately, and C(qb) represents the cost of producing good b in the quantity of qb separately.
The cost of generating quantities qa and qb jointly is C(qa+qb).
The percentage cost savings when the commodities are produced jointly is known as Economies of Scope (S). Therefore, in the presence of economies of scope, S would be bigger than 0.
An illustration of economies of scope
For instance, a restaurant serves sandwiches and hamburgers. One million hamburgers are produced at a cost of $0.50 apiece. Similarly, if 4,000,000 sandwiches are made individually, each one will cost $0.30. The combined cost of producing one million hamburgers and four million sandwiches (using the same equipment for preparation and storage) comes to $1,500,000.
To ascertain the scope of economies:
C(qa) = 1,000,000 * 0.50 = $500,000 can be found.
For C(qb) = 4,000,000 * 0.30 = $1,200,000, find
Calculate that C(qa+qb) = $1,500,000.
Enter ($500,000 + $1,200,000 – $1,500,000) / $1,500,000 = 13.33% in the Economies of Scope calculation. As a result, making sandwiches and hamburgers together is 13.33% less expensive than making them separately.
How Can Economies of Scope Be Attained?
1. Adaptable Production
When two products may be made with the same manufacturing processes and inputs, such as when hamburgers and fries are made in the same preparation and storage facilities rather than two different facilities, this is known as flexible manufacturing.
2. Corresponding Diversification
A corporation can benefit from related diversification if it can leverage its operational expertise, resources, and competencies throughout its organization. A broad range of products can be produced, for instance, by employing marketers and designers who can apply their expertise to several product lines.
3. Consolidations
In order to cut costs and broaden its product line or expertise, mergers frequently allow a corporation to split research and development expenditures. For instance, two pharmaceutical firms may unite in order to pool their resources for product development.
Economies of scope against economies of scale
Economies of scope are commonly confused with economies of scale. The former refers to the drop in average total cost of production that occurs when the variety of items produced increases. Economies of scale, on the other hand, are cost savings realized by increasing the scale of production of a single good.
Economies of scale: Cost savings resulting from greater manufacturing of different items utilizing the same processes. Economies of scale lower the average cost of producing many products.
Economies of scale are cost savings achieved by larger manufacturing of the same product. Economies of scale reduce the average cost of producing a single product.
The significance of economies of scope
Economies of scope enable a corporation to increase efficiency by producing a wider range of items. A corporation can sell a wider choice of products while simultaneously adapting to changes in consumer preferences. It decreases a company’s risks by enabling relevant diversification. If a large automobile manufacturer primarily built SUVs, the company would be subject to market shifts (for example, if oil prices rise and people convert to buying more eco-friendly cars).
Related Readings
To learn more and advance your career, check out the following free CFI resources:
Market Economy Cost Structure
Law of Supply
Inelastic demand
Newly industrialized country (NIC)
See all economic resources.