Demir writes*
In microeconomics, economies of scale occur when firms reduce average costs per unit as production expands. Graph 1 illustrates this through the long-run average cost curve (LRAC), which declines as output increases from Q to Q₂, showing cost efficiency gains from reduced labour costs, improving efficiency and overall technological advantages one might have (Wikipedia).
By moving from Q to Q2, the firm lowers per-unit costs from C to C1, which allows it to better compete on price. When economies of scale are so extensive that a single firm can serve the entire market at a lower cost than multiple competitors, a natural monopoly may form. This typically occurs in industries with high fixed costs and significant cost reductions from increased output, allowing one dominant firm to outcompete smaller rivals (Wikipedia). This situation might occur if Q₂ is close to total quantity demanded in the market, which means that smaller competitors will not be able to enter the market and compete on cost.
Amazon leverages its economies of scale in automation, bulk purchasing, and logistics to lower prices and dominate markets. But how did Amazon achieve such market domination?
From warehouse robotics to dynamic pricing algorithms, Amazon automates key operations, reducing labour costs and improving efficiency. These systems optimise pricing in real-time, allowing Amazon to offer the most competitive prices. Amazon’s purchasing power allows it to buy goods at lower prices than competitors. Suppliers, reliant on Amazon’s vast customer base, offer significant discounts that smaller retailers cannot access. Third-party sellers can use Fulfillment by Amazon (FBA) for logistics, thereby reinforcing economies of scale in speed, price and reach.
While its e-commerce business operates on thin margins, profits from Amazon Web Services (AWS) subsidizes retail operations. Amazon’s 200 million-plus Prime members spend twice as much as non-members, further reinforcing economies of scale. Amazon’s logistics dominance raises concerns about natural monopoly status. Its cost advantages make it nearly impossible for competitors to match its efficiency. Many retailers now depend on Amazon’s distribution network instead of building their own. While this benefits consumers through low prices, it also risks future price increases if competition erodes. Governments are beginning to scrutinise Amazon’s market power, raising questions about potential regulatory intervention (Shah & St John 2021).
Bottom Line: Amazon’s ability to offer low prices, fast delivery, and an extensive product range is a direct result of economies of scale. Its bulk purchasing, automation, logistics network, and AWS revenue create an unbeatable cost advantage. As Amazon continues expanding, the debate over its influence will shape the future of e-commerce regulation.
* Please help my Applied microeconomics students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice 🙂
I really liked the post Demir! It’s interesting to see these giant firms and how they affect competition. Amazon may be cheap and have benefits such as fast delivery but it’s dominance makes diversity practically nonexistent at this point.
Hi Dominika, yes indeed Amazon’s business model makes it hard for others to, essentially, “catch up” and enter the market as competitors. For now there are not many international competitors against Amazon. But I think Bol.com in the NL is a good example of how you can have local competition. I believe the role of the government is important here regulating and making sure that there is a viable environment for companies to enter the market.
Hi Demir, thank you for your clear explanation of economies of scale. Amazon is a great example.
When it comes to natural monopolies like Amazon, I think that the role of regulation becomes crucial to maintain a competitive market and protect consumer welfare. Governments can regulate monopolies in several ways to ensure that consumers still benefit from competition and fair prices. For instance, price regulation can prevent monopolistic firms from abusing their market power by charging consumers ridiculous prices. Anti-trust laws, like those seen in the European Union and the U.S., also play a significant role by breaking up or limiting the size of firms that achieve overwhelming market share through economies of scale. For example, the EU’s regulatory approach towards Google and Amazon’s dominance in advertising and cloud services could serve as a model for regulating Amazon’s retail operations.
On the other hand, economies of scale often present a paradox for regulators: while large firms benefit from cost reductions and technological advancements that can offer consumers lower prices, there’s also the risk of stifling competition and innovation if smaller firms are pushed out. A key question then becomes: How can regulation create a balance between promoting efficiency through economies of scale and protecting the market from becoming too concentrated?
For consumers, the lower prices resulting from economies of scale are undeniable advantages. However, they may not always be aware of the long-term costs of reduced competition, such as reduced product diversity and the risk of price spikes when monopolies have fewer competitors to compete with. Let alone the environmental costs 😉
Hi Sarah, thank you for your comment. I think when it comes to Amazon specifically they do act more as an intermediary however government oversight and regulation is key to prevent monopolistic behaviour as you mentioned. So it is very much up to the authorities to monitor the behaviour of such companies (the EU being a good example). However, as you also mention there is a fine balance between oversight & regulation and having an environment where innovation can strive. It is very much hard to balance, so my conclusion would be that competition is always a good option, but it is not always clear if the parties involved (the government & the company(ies)) are willing.