there are two types of economics of scale

8/3/2019 There Are Two Types of Economics of Scale

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There are two types of economics of scale:

Internal Economics of scale

External economics of scale

Internal economics of scale:

Internal economies of scale arise because of the growth in the scale of production

within a firm. Five main types of internal economies of scale can be defined.

1. Technical economies. They are found mostly in plants and arise mostly

because neither the capital cost nor the running cost of plants increase inproportion to their size. The main idea is to spread the fixed costs over as large

output as possible, so AFC decreases.

2. Managerial or administrative economies arise because the same people can

usually manage with bigger output, so average administrative cost decreases when

production increases. Large firms can employ specialists, which leads to the

increase in efficiency.

3. Financial economies arise because e.g. the interest rate for getting a loan is

higher for smaller firm that for larger one. This is because large firms have large

assets and bank trusts them more. It is also relatively easier for large firms to raise

their share-capital by issuing shares.

4. Marketing economies. They are available both in purchases of raw material

and in selling of the product. A large firm may have a bulk discount when

purchasing raw materials. In terms of promotion, to large firms the average cost is

smaller, because the prices of advertisements are the same for all firms.

5. Social economies. They may be developed into two groups: those which build

up the goodwill of the community and so attract customer (sponsorship), and those

that develop the loyalty of the firm's employers (Christmas bonuses).


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6. Risk bearing economics:

Risk-bearing economies. They are the firm's ability to bear losses. If one part of the

company has a loss, other parts of the company can support it. If the company

sustains a loss, it has enough capital to overcome it

External economies of scale arise when there is a growth in the size of the

industry and are available for many firms in it. There are three main types of

external economies.

1. Economies related to a particular industry. They are derived from the

concentration of the industry in one place and differ between industries. They might

involve cheaper training facilities if many firms want to train their employers or

marketing economies when several firms want the same kind of raw material. Theycan be realized through trade associations which are producers' unions, which can

e.g. advertise the industry generally, thus raising the revenue of all the firms

included.

2. Economies related to industrialization. If there is a great concentration in

specific place, e.g. many people come to look for job there. Usually the

communication expenses (maintenance of roads) can be shared. The activities of

the essential services sector multiply, providing more advantages to firms in the

industrialized area.

3. Economies related to society. The provision of roads, schools etc. is largely

the responsibility of the state. As industrialization increases the provision of these

items increases giving further advantages to firms in the area.

As firm expands its activities beyond a certain size, called the optimum size, the

unit cost may begin to rise again. So they occur if an equal percentage increase in

inputs leads to a less than equal change in output. It is also called the diminishing

returns. Diseconomies of scale can be divided into external and internal economies,

just like economies of scale.

Internal diseconomies of scale include technical diseconomies, which include the

further cost of enormously big plants and their relatively big loss, when one part


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fails. Administrative diseconomies are also existing. It is relatively expensive to

inform staff in big firms, also the obeying of commands may take very long time.

External diseconomies of scale arise mostly as a result of the overcrowding of

industrial areas. This will lead to the increase in the price of land, labour and

services. An obvious example is the congestion costs resulting from high traffic

densities.

Diseconomies of Scale:

The extensive use of machinery, division of labor, increased specialization and

larger plant size etc., no doubt entail lower cost per unit of output but the fall in cost

per unit is up to a certain limit. As the firm goes beyond the optimum size, the

efficiency of the firm begins to decline. The average cost of production begins torise.

Factors of Diseconomies:

The main factors causing diseconomies of scale and eventually leading to higher

per units cost are as follows:

(i) Lack of co-ordination. As a firm becomes large scale producer, it facesdifficulty in coordinating the various departments of production. The lack of co-

ordination in the production, planning, marketing personnel, account, etc., lowers

efficiency of the factors of production. The average cost of production begins to rise.

(ii) Loose control. As the size of plant increases, the management loses control

over the productive activities. The misuse of delegation of authority, the redtapisim

bring diseconomies and lead to higher average cost of production.

(iii) Lack of proper communication. The lack of proper communication between

top management and the supervisory staff and little feed back from subordinate

staff causes diseconomies of scale and results in the average cost to go up.


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(iv) Lack of identification. In a large organizational structure, there is no close

liaison between the top management and the thousands of workers employed in the

firm. The lack of identification of interest with the firm results in the per unit cost to

go up.

there are two types of economics of scale

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