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Economies of Scale and Consumer Welfare

A-Level, IB
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 30 Sept 2018

Here is a suggested answer to this question: "To what extent do consumers always benefit from businesses experiencing economies of scale?

Economies of Scale and Consumer Welfare

Point 1

The impact of economies of scale on consumer welfare can be measured in several ways. One approach looks at the real prices customers pay for a product and another is to estimate the amount of consumer surplus at the profit-maximising level of output.

In theory, internal economies of scale lead to lower average costs and reduced prices for consumers in the long run. Lower prices cause an expansion of market demand and bring about an improvement in consumer welfare shown by an increase in consumer surplus. The impact of economies of scale can be magnified if a number of businesses can each achieve scale because when this happens, competition between suppliers in a contestable market is likely to intensify price competition and bring prices down further. Households on below-average income might benefit from cheaper prices for essential goods and services. This increases the real value of each hour worked.

However, a counter-argument is that economies of scale can lead to increased monopoly power in an industry and there is no guarantee that prices will fall. For example, Netflix has gradually increased their monthly subscription rates in the UK and Uber has been widely criticised for their use of algorithms to bring in surge pricing at times of peak demand as a tactic to drive higher returns for shareholders. Many well-known digital businesses now use sophisticated tracking of consumers and algorithmic price-setting to extract consumer surplus from customers and turn it into increased producer surplus.

Point 2

Economies of scale can also lead to improved consumer welfare by improving profitability which then finances gains in dynamic efficiency.

For example, Netflix’s commercial success has generated the profits to enable them to invest $ billions annually into new programming and cutting-edge digital technologies that make streaming quicker and more reliable across a growing range of programme genres including drama and live sport. In the case of Amazon, the scale of choice available to consumers in “The Everything Store” is vast and their platform is also an opportunity for smaller businesses to sell to new customers encouraging diversity of supply in consumer goods markets.

However although in theory increasing returns to scale and resulting profits can accelerate research & development and innovation, in practice the impact might work in the opposite direction. One might argue that digital monopolies such as Uber and Netflix work against consumer welfare because smaller firms are squeezed out. Major innovation is often due to new entrants rather than incumbents. Dominant platforms reduce competition and there are many critics of the tax avoidance policies of Amazon & others which lowers the return to the Treasury. These tax revenues might have promoted consumer welfare through better-funded public services including education and health. Amazon paid only £4.5m in UK corporation tax last year. Netflix paid no UK corporate tax in 2017.

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