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1. **Definition**: Economy of scale refers to the cost advantages that a business can achieve due to an increase in production or scale of operation. Essentially, as a company produces more units of a good or service, the average cost of producing each unit decreases.
2. **How it works**: This concept is based on spreading fixed costs, such as overhead expenses, over a larger number of units. For example, a factory that produces 1000 units of a product will have lower average costs per unit compared to a factory producing only 100 units, as the fixed costs are divided among a greater quantity of products.
3. **Examples**:
- A car manufacturer benefits from economies of scale by producing a large number of cars on the same assembly line, reducing the average cost per car.
- Bulk purchasing discounts are another example where larger quantities lead to lower costs per unit, benefiting from economies of scale.
4. **Implications**: Companies can use economies of scale to improve profitability, offer competitive prices to customers, and potentially dominate markets by driving out smaller competitors who can't achieve the same cost efficiency.
In summary, economy of scale is the cost advantage gained through increased production levels, leading to lower average costs per unit produced.
