A Small Firm is Likely to Be Less Efficient than a Large Firm

Large firms tend to benefit more due to several factors from economies of scale; this means that the firm can benefit from falling average costs in the long run – however small firms cannot achieve such benefits. For example purchasing benefits whereby large firms are able to bulk buy raw materials as they are producing on a larger scale thus are able to receive discounts and therefore reducing production costs. Or they may experience technical economies whereby investment in more advanced machinery or larger premises will allow firms to experience increasing returns to scale where output is greater than input thus improving productive efficiency through division of labour and specialisation resulting again in lower costs. Economies of scale can be illustrated in diagram 1, whereby when output increases (Q to Q1), cost decreases (C to C1). Minimum efficient scale is illustrated at the constant part of the LRAC labeled QA firms are operating at the optimum point experiencing constant long run average costs where economies of scales are exhausted; the firm therefore is operating at long-run productive efficiency. This is the reason why large firms are considered to be better than small firms.

However as the LRAC curve rises; large firms will experience diseconomies of scale. For example as a firm grows control becomes more difficult, monitoring productivity of each worker in a large firm will become more challenging thus may result in a loss of productive efficiency and therefore rising average costs. Additionally coupled with poor communication and co-ordination due to increasing size of firms increasing average costs are accelerated. Furthermore as large firms are often public limited companies ownership and control is often divided among a group of shareholders thus control over the firm is not subject to one person and instead are run by several directors who carry the interest of the shareholders. This makes management over large firms more difficult as negotiations and meetings are needed to carry out various operations thus reducing the efficiency of the firm whereas small firms are usually owned by one person thus management and decisions are able to be made swiftly. Also communication and co-ordination in small firms are much easier to manage and is less costly due to smaller amount of factors of production. In this sense, small firms can be argued to work more efficiently than large firms.