Expanding a business - AQADiseconomies of scale

Diseconomies of scale occur when average unit costs begin to increase, often as a result of business growth. This is one of the main risks that an expanding business may face.

What causes diseconomies of scale?

Diseconomies of scale can be caused by problems with communication as the firm expands possibly into different locations or internationally. Decisions take longer to reach all employees because communication is more difficult.

Diseconomies of scale can also be caused by coordination issues as managers are in charge of increasing numbers of employees. These can lead to reduced staff motivation and lower productivity, which increases unit costs.

Calculating average unit costs

The formula for calculating unit costs is:

Unit costs = total costs ÷ output

If a business has total costs of £200,000 and produces 100,000 units, the unit cost is:

£200,000 ÷ 100,000 = £2

If the business increases production to 200,000 units and total costs increase to £250,000, the unit cost is:

£250,000 ÷ 200,000 = £1.25

Unit costs have decreased. This shows that the business is experiencing economies of scale.

The business then increases production to 300,000 units and total costs increase to £400,000, therefore the unit cost is:

£450,000 ÷ 300,000 = £1.50

Unit costs have increased. This shows the business is experiencing diseconomies of scale.