Internal and External Economies and Diseconomies of Scale

Internal and External Economies and Diseconomies of Scale

Micro Economics Notes

In this article, we are going to discuss about Internal and External Economies and Diseconomies of Scale. Micro Economics Notes

Internal and External Economies of Scale

Now-a-days, goods are produced on a very large scale in modern factories. When the production is carried on a large scale the producer derives a number of advantages or economies. These advantages of large scale production are called economies of scale. This is the reason why entrepreneurs try to expand the size of their factories. Marshall divides the economies of scale into groups

(i) Internal economies and

(ii) External economies.

Internal Economies

A producer drives a number of advantages when he expands the size of his factory. These advantages are called internal economies. They arise because of increase in the scale of production (i.e. output that can be produced). These are secured only by the firm expanding its size. They are dependent on the efficiency of the organizer and his resources.

So internal economies are those advantages which are obtained by a producer when he increases or expands the size of his firm. Internal economies are divided into various classes as follows. When a firm increases its scale of production it enjoys several economies. These economies are called internal economies.

Types of Internal Economies

There are two types of internal economies:

1. Real Economies:

Real economies are those which are associated with a reduction in the physical quantity of inputs, raw materials, various types of labour and various types of capital. Real economies can be of six types:

a. Labour Economies or Specialization: Specialization means to perform just one task repeatedly which makes the labour highly efficient in its performance. This adds to the productivity and efficiency of the labour.

b. Technical Economies: Technical economies are those economies which are related with the fixed capital that includes all types of machines & plants. Technical economies are of three types:

– Economies of Increased Dimension.

– Economies of Linked Processes.

– Economies of the use of By-Product.

c. Inventory Economies: A large size firm can enjoy several types of inventory economies; a big firm possesses large stocks of raw material.

d. Selling or Marketing Economies: A firm producing a large scale also enjoys several marketing economies in respect of scale of this large output.

e. Managerial Economies: A firm producing on large scale can engage efficient & talented managers.

f. Transport and Storage Economies: A firm producing on large scale enjoys economies of transport & storage.

Also Read:

Laws of Returns to Scale and Its Types

Perfect Competition – Meaning, Features, Assumptions and Limitations

2. Pecuniary Economies:

Pecuniary economies are economies realized from playing lower prices for the factors used in the production and distribution of the product due to bulk-buying by the firm as its size increases.

External Economies

When the number of factories producing the same commodity like sugar increases, we say that the particular industry (sugar industry) has developed. When the industry as a whole develops, every firm in the industry derives man advantages. These advantages are called external economies. They are enjoyed by all the firms in the industry. They are not the property or monopoly of any firm. The following are the main types of external economies:

1. Economies of Concentration: When several firms of an industry establish themselves at one place, then they enjoy many benefits together, e.g. availability of developed means of communications and transport, trained labour, by products, development of new inventions pertaining to that industry etc.

2. Economies of Information: When the number of firms in an industry increase, then it becomes possible for them to have concerted efforts and collective activities.

3. Economies of Disintegration: when an industry develops, the firms engaged in its mutually agree to divide the production process among themselves.

Internal and External Diseconomies of Scale

The term diseconomies of scale refer to a situation where an increase in the size of the firm leads to a rising average cost. Diseconomies of scale may be classified into internal diseconomies and external diseconomies of scale.

The major internal diseconomies of scale arise from its size of the firm, technical causes and managerial problems. When a firm achieves a size where it is producing at the lowest possible average cost it is said to be at its optimum size. The optimum size will very over time as technological progress change the technique of production. In addition to this, more loaded men and machinery leads to machine fault and human failure cause breakdown of production.  When the size increases management becomes more complex and difficult. Managerial function of co-ordination, consultation and interdepartmental decision making will get delayed due to the size.  There will be possibility of delay in implementation of decision within the organization. Delay in communication will reduce the involvement of the employees.

There are some external diseconomies of scale in the form of disadvantages:

1. There is shortage of labour which causes a wage rise.

2. Increase in the demand for raw materials will also bid up prices.

3. When there is heavy localization of industries, the land forexpansionwill become increasingly scarce.  Scarcity will cause an increase in the price to purchase land or to rent.

4. Transport costs may also rise because of increased congestion.

The change in output will cause a movement along the long run average cost curve. One of the most significant influences is external economies of scale.  If external economies are experienced, the long run average cost will shift down (output will be now be cheaper to produce).  Whereas external diseconomies of scale are encountered the long run average cost curve will move up (output will now be costlier to produce).  Improved technology would lower the long run average cost curve.

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