Here is a practice question and model answer. These are written in the style of AQA Economics A Level.
Essay question
The practice question is as follows:
Explain possible reasons why firms may experience economies of scale (15 marks).
Below is a model answer to this question.
Model answer
Economies of scale are when long-run average cost (LRAC) decreases as output increases. Internal economies of scale occur within the firm, as the firm decides to increase its output.
Purchasing economies of scale means a larger firm can bulk-buy inputs at a per-unit discount relative to a small buyer. This reduces long-run average costs for the firm. This is a type of internal economies of scale – economies of scale controlled by the company. An increase in output from q to q1 leads to a movement along the LRAC from c to c1, reducing LRAC. For example car companies like Ford buy car tyres in bulk for a discounted per-unit price.
Firms also have financial economies of scale – larger firms can receive loans at lower interest rates, reducing the cost of borrowing for firms and reducing the firm’s long-run average costs as output rises. An example is Google still borrowing money despite having a high cash flow, with parent company Alphabet holding over $14 billion of long-term debt in 2022. Larger firms like Google are seen as more likely to pay back loans. This could be because larger firms have more assets to use as “collateral” (assets to give the lender in case of failure to repay loans). In Google’s case, this could include the various businesses Alphabet (Google’s parent company) has acquired, as well as its servers and buildings. Larger firms can also spread a given borrowing cost over a larger output base.
External economies of scale originate outside of the firm. One type is agglomeration economies of scale. This is where firms in the same industry concentrate their activity in a particular area. For example tech firms, such as Alphabet (Google), Apple and Meta tend to concentrate their activity in Silicon Valley in the US. The area has a large number of technology workers, so this makes it easier for tech firms to hire new workers. For example application processes are shorter, easier and hence cheaper, reducing long-run average costs for the firm. External economies of scale shift the long-run average cost curve down from LRAC to LRAC1. At a given output level q, this reduces LRAC from c to c1.
Commentary on the answer
This answer is a high level answer. In particular it contains:
- Three types of economies of scale, well explained.
- Appropriate use of cost curve diagrams, linked to the question.
- Use of real world examples throughout, including Bayer, technology companies and Ford.
- Appropriate definitions of relevant terms, such as economies of scale.
As a result, this answer is likely to score full marks or close to this.
This is just one essay structure that can score well. Other essay structures could also score highly.
An alternative structure would be two detailed analysis points, instead of three succinct analysis points as above.
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