ECONOMIES OF SCALE
As firms start to grow in size, they might start to experience reductions in their average costs of production
Economies of Scale: as a firm's output increases, the average costs of production start to fall
ATC = total costs/ quantity produced
Internal economies of scale can result from:
Bulk Buying economies
Managerial economies
Financial economies
Technical economies
As a firm increases in size, it enjoys economies of scale, which enables it to reduce its average costs of production. Such a benefit can be viewed as a barrier to entry, allowing the firm to lower its costs and prices, deterring new firms from coming into the market since they cannot experience the lower costs and prices of the existing firm. The existing firm could then develop monopoly power
Natural monopoly: if an industry has the potential to generate substantial economies of scale, it becomes worthwhile for that one firm to be the only provider in the industry, so that the full economies of scale can be achieved. These are usually industries with high fixed costs and low running costs, eg electrical power and gas distribution. Having one provider allows the fixed costs to be spread across one firm, and also reduces the duplication of resources which would be associated with several firms having to provide a grid network.