A firm exhibits economies of scale if the average cost of producing a good falls as the quantity produced rises.
Fixed costs are an important source of economies of scale.
Say a hamburger store has fixed costs of $10,000 per month (store rent, salaries, insurance, utilities). The variable cost per hamburger is $0.50 (variable costs are those that vary with the quantity of burgers produced e.g. ingredients, labor).
|Quantity Produced (per month)||Fixed Cost (per burger)||Variable Cost (per burger)||Average Total Cost (per burger)|
This hamburger store exhibits economies of scale: as the quantity produced increases the average total cost falls.
Economies of scale are good! If the price is fixed (say at $2 per burger), then the profit per hamburger increases as more are sold.
Internet Businesses Exhibit Economies of Scale
Many internet businesses exhibit large economies of scale, because many of their costs are fixed. For example, many of eBay's costs come from servers and software development, and these do not increase with the number of customers. Every additional transaction lowers the average cost of a transaction.
Economies of scale are also know as increasing returns to scale.