Final answer:
Economies of scale occur when a firm can produce a good or service at a lower per unit cost due to large quantity production, resulting in decreased average costs. This principle supports the business models of warehouse stores such as Costco or Walmart. It also explains how companies can compete more effectively on price at higher production levels.
Step-by-step explanation:
Economies of scale refer to a cost advantage that is created when a firm can produce a good or service at a lower per unit price due to producing the good or service in large quantities. Once a firm has established the most efficient production technology, it looks at the optimal production scale. Large-scale production leads to a reduction in the average cost per unit which is the essence of economies of scale. For instance, a larger factory can achieve a lower average cost than a smaller one.
Companies like Costco or Walmart, which operate on the model of warehouse stores, are prime examples of enterprises utilizing economies of scale. They buy and sell products in bulk, which allows them to offer lower prices to customers. A curve showing this effect would depict the average cost of production decreasing as output increases, up to a certain point. Beyond that point, called the minimum efficient scale, increasing production doesn't significantly decrease costs.
However, the advantage of economies of scale is not limitless. For example, the economy of scale for a semiconductor factory may extend up to a production of 40,000 units. Beyond this, average production costs may not decline. In high-demand scenarios, numerous factories might operate, all benefiting from economies of scale. In instances where demand is below a threshold, a firm or economy might not be able to fully leverage economies of scale without engaging in external trade.