What are economies of scale?

Economies of scale refer to the concept where the average cost per unit of production decreases as the scale of production increases. This occurs because fixed costs, such as rent and salaries, are spread over a larger number of units. As production ramps up, businesses often also benefit from operational efficiencies and bulk purchasing discounts, leading to a reduction in the average cost per unit.

For example, a factory that produces 1,000 units of a product may have a lower cost per unit than a factory that only produces 100 units because the fixed costs and initial investments are distributed among more units. This principle is crucial in understanding how larger companies can operate more efficiently and competitively compared to smaller entities or those producing at lower volumes.