If you’re taking A Level Economics or currently enrolled in a tuition, understanding how firms grow and make decisions is essential. Concepts such as economies of scale (EOS) and mergers and acquisitions (M&As) help explain how businesses reduce costs, increase profits, and strengthen their market position.
Whether you’re revising on your own or studying economics, this blog breaks down these important topics using real-world examples, simple explanations, and clear definitions to support your learning.
1. Understanding Economies of Scale (EOS)
Economies of scale refer to the cost advantages a business can enjoy as it expands production. They are typically divided into two categories:
a. Internal Economies of Scale
These are cost savings that come from the growth of the firm itself.
- Definition: Internal EOS are reductions in per-unit cost due to a firm’s increased output and scale of production.
- Impact on LRAC: As the firm grows, it moves along its Long-Run Average Cost (LRAC) curve, lowering average costs until it reaches the Minimum Efficient Scale (MES).
Examples:
- Technical EOS: Firms like SingTel spread the cost of indivisible assets, such as network infrastructure, over a large customer base.
- Marketing EOS: Companies like Grab reduce average advertising costs by promoting new services to existing users (e.g. from ride-hailing to food delivery).
- Financial EOS: Larger firms such as Grab may raise funds from major investors like SoftBank more cheaply than smaller firms can borrow from banks.
- Minimum Efficient Scale (MES) is the level of output where the firm fully benefits from internal EOS. Beyond this point, further growth doesn’t reduce costs significantly.
b. External Economies of Scale
These are cost savings that result from the growth of the whole industry, not just the individual firm.
- Definition: External EOS are reductions in costs due to industry-wide developments, such as improved infrastructure, shared resources, or government support.
- Impact on LRAC: These savings shift the entire LRAC curve down, lowering costs for all firms regardless of size.
Examples:
- Economies of Information: In places like the Jurong Innovation District, research sharing and collaboration lead to industry-wide benefits.
- Economies of Concentration: A larger industry attracts more skilled workers, reducing training costs. The Bosch Rexroth Training Centre in Singapore is a good example.
While internal EOS can influence a firm’s decision to grow, external EOS tend to benefit all firms equally and have less impact on individual firm size.
2. Mergers and Acquisitions (M&As): Benefits and Risks
M&As are often used by firms to expand, cut costs, or increase revenue. These decisions are usually made with profit maximisation in mind, though governments may also play a role in regulating them.
Justifications for M&As
Achieving Higher Internal EOS
Particularly in horizontal integration, where firms merge with competitors at the same stage.
- Example: Grab’s acquisition of Uber Southeast Asia helped reduce average costs by combining operations and spreading fixed costs.
- Impact: Lower Average and Marginal Costs (AC and MC) can increase output and supernormal profits.
Increasing Market Power
By merging with rivals, a firm may face fewer competitors and enjoy greater pricing power.
- Impact: A steeper demand curve (Average Revenue or AR) allows firms to charge higher prices and raise profits.
Network Effects
In industries like tech or transport, a larger user base increases the value of the service.
- Example: Grab’s “super app” benefits more users when there are more drivers and riders on the platform.
Risk Diversification
Firms may merge across different industries (conglomeration) to spread risks.
- Example: General Electric operates across aerospace, energy, and finance, reducing reliance on any one sector.
Cost Savings through Vertical Integration:
Merging with suppliers or distributors lowers costs by avoiding external mark-ups.
- Example: Supermarkets owning farms instead of buying from third-party suppliers.
Drawbacks of M&As
Internal Diseconomies of Scale:
Growing too large can increase costs rather than reduce them.
- Causes: Complex coordination, communication delays, low employee morale.
- Example: Post-merger, Grab struggled with coordination across countries and managing ex-Uber staff.
Market Dominance and Consumer Harm:
Dominant firms may raise prices and reduce output, harming consumer welfare.
- Impact: Lower consumer surplus, higher allocative inefficiency, and wider gap between price and marginal cost.
- Example: Grab and Uber were fined in Singapore for reduced competition.
Regulatory Scrutiny:
Governments may intervene if market dominance threatens competition laws.
- Authorities aim to prevent monopolistic practices and maintain fair markets.
Contestable Markets
In markets where new firms can easily enter and compete, dominant firms face pressure to behave competitively.
- Example: Go-Jek’s entry into Singapore after Grab’s acquisition of Uber served as a check on Grab’s dominance.
3. The Link Between EOS and M&As
While achieving internal EOS is a common motive for mergers, it is not the only reason. The extent of EOS depends on the industry and its minimum efficient scale.
For instance, in sectors with small MES (e.g. tuition centres), M&As may aim more at reducing competition and increasing market power rather than cutting costs.
Hence, understanding the role of EOS in M&As requires evaluating both the firm’s goals and industry structure.
Conclusion
For students revising for A Level exams or enrolled in an A Level Econs tuition, mastering the concepts of economies of scale and mergers is vital for analysing real-world business behaviour.
- Internal and external economies of scale influence how firms grow and reduce costs.
- Mergers and acquisitions are strategic moves to boost profit, but they also come with risks like inefficiencies and regulatory scrutiny.
- Firms may pursue M&As not just for cost savings but also for greater market power, revenue, and risk diversification.
- Industry structure and government regulation play a crucial role in shaping the outcomes of these business strategies.
If you’re attending economics tuition, make sure to link theory with current examples, as this strengthens your exam answers and deepens your understanding of how firms operate in competitive and regulated markets.