Economies and Diseconomies of Scale

Economies of Scale:

• Anything which minimises the average cost of production in the long run as the scale of output is increased.

• Its measured in physical terms

1) Internal Economies

2) External Economies

Internal Economies

• The factors, indigenous to the firm makes the cost of production falls.• It’s exclusive to the firm and not available to other firms

a) Labour Economies

In long run specialisation of labour leads to increase in efficiency which leads to increased productivity and lower cost of production.

b) Technological Economies

In the long run more efficient and advanced technology can be used for large scale production which can also be used for composite production processes.

c) Managerial Economies

Reduction in managerial cost as with large scale production specialist managerial staff can be placed to perform the managerial functions.

Internal Economies

d) Marketing Economies

The buying of inputs (raw material) and selling (goods produced) can be done more efficiently and effectively by large firms doing large scale production.

e) Financial Economies

The cost of obtaining credit and capital is lower to a large firms and big firms are regarded as less risky.

f) Risk minimising Economies

Large firms divide risk by diversification. It helps to offset losses by making profits in certain line of business.

External Economies

• They are external to the firms• Such economies are available to all firms / Industry

a) Economies of concentrationWhen all firms mutual advantages of facilities – labour, transport, banking and financial services, infrastructure, etc . It leads to reduction in operational cost.

b) Economies of Information and Marketing IntelligenceEstablished Industry can bring about trade and technical publications which is accessible to all firms.

c) Economies of SpecialisationFirm level specialisation leads to increase the productivity of the firm. Each stage can be disintegrated and specialised which can lead to better production.

Diseconomies of Scale

Diseconomies of scale:

When a firm expands beyond a optimum level.

The average cost rises and leads to diseconomies

1. Difficulties of management

2. Difficulties of Co-ordination

3. Decision – making

4. Increased risk

5. Labour Diseconomies

6. Scarcity of factor supplies

7. Financial difficulties

8. Marketing Diseconomies

Economies of Scope

Cost effective for a single firm to produce more than one product than for separate firms to produce an equal quantity of output of the same product.

1) In case of a firm produces several products: common production facilities and inputs

2) Production of one good results in by-products that can also be sold by producers.

Economies of Scope

Degree of economies of scope =

TC (Q1) + TC (Q2) – TC (Q1 + Q2)

TC (Q1 + Q2)

TC (Q1) = Total cost of production Q1 units of good 1

TC (Q2) = Total cost of production Q2 units of good 2

TC (Q1 + Q2) = Total cost of producing goods 1 and 2 jointly

• If Degree of Economies of Scope

– Positive: Economies of Scope exist. Producing goods jointly is cheaper

– Negative: Producing goods separately is cheaper