Let’s say there is an illegal drug firm called ‘Drugs R Us’ and they are growing. Below is a brief summary of the types of economies of scale Drugs R Us may experience.
Economies of Scale
As Drugs R Us grows, its LRAC falls because of:
Technical economies. Drugs R Us could buy specialist machinery to smuggle more drugs on trucks to decrease transport costs.
Purchasing economies. Drugs R Us could buy bigger quantities of drugs from Colombia to benefit from bulk-buying so that unit input costs fall.
Managerial economies. Drugs R Us could hire ‘muscle’ on the street to make sure their drug dealers are not stealing their drugs or money.
Financial economies. Drugs R Us are larger and more profitable so they are less risky and should receive lower interest rates from loan sharks.
Diseconomies of Scale
As Drugs R Us grows, its LRAC may rise because of:
Managerial diseconomies. Drugs R Us’ managers may not be able to efficiently deal with all of its drug dealers on the streets. Some of its drug dealers may move onto a rival drug firms’ patch and start a costly turf war.
Risk-bearing diseconomies. Drugs R Us may become too big and increase its risk of being discovered and taken down by the police.
External Economies of Scale
All the firms in the illegal drugs market may benefit from something that reduces their costs. For example:
Technological advance. New technology may be developed that makes it easier to smuggle drugs. For example, an X-ray proof plastic sleeve may be invented. Drugs R Us can then transport drugs across borders more cheaply.
Better education. Better educated scientists may mean better quality drugs. Scientists may develop seeds that grow better hallucinogenic drugs.
External Diseconomies of Scale
All the firms in the illegal drugs market may suffer from something that increases their costs. For example:
A police crackdown. A police crackdown on drugs means Drugs R Us is at a higher risk of being caught so it must take extra measures to avoid being caught. Maybe Drugs R Us must bribe the police, increasing Drugs R Us’ costs.
Natural disaster. A natural disaster like a volcano or freak weather like a tornado destroys drug crops meaning drug crops must be replanted, resulting in higher costs for Drugs R Us.