Final answer:
Economies of scale occur as a firm's production output increases and average costs per unit decrease. However, diseconomies of scale, where costs rise with increased output due to management inefficiencies, do not contribute to economies of scale. Firms should grow with caution to avoid diseconomies of scale.
Step-by-step explanation:
As a firm grows larger and achieves a certain level of output, it benefits from economies of scale, where the long-run average cost of producing output decreases as total output increases. This typically occurs due to factors like the spreading of fixed costs over a larger quantity of production, improved bargaining power when purchasing inputs, and more efficient use of technology or production techniques.
However, not all aspects of increasing the size of a firm lead to lower per-unit costs. Diseconomies of scale occur when a firm becomes too large and average costs start to rise, which is a result of issues such as complex management structures leading to poor communication and inefficiencies. This condition contradicts the concept of economies of scale and is not a factor in reducing costs as a firm grows.
Economies of scale are sought by firms like warehouse stores, such as Costco or Walmart, which operate under the principle that a larger operation can produce goods at a lower average cost than a smaller one. However, firms must be aware of the diseconomies of scale to avoid the pitfalls of excessive growth.