BE/U3 Topic 5 Internal and External Economics and Diseconomies
Economies and Diseconomies of Scale
Economics of scale arises when the marginal cost of production decreases, whereas because of the diseconomies of the scale there is an increase in sales. These are the cost advantage that an organization obtains due to their scales of operation. Diseconomies are the cost disadvantages that firms build up due to an increase in firm size or output.
This result in the production of goods and services at increased per unit costs. Economics of scale leads to cost reduction and diseconomies rise the cost. These both factors also determine the return to scale and they are opposite to each other.
Economies of scale also refer to the saving made in terms of cost of producing each unit of production as a result of increasing size.
When the economies are more than the diseconomies, the return to scale increase. When the economies balance the diseconomies, the return to scale is constant. However, when the diseconomies are more than the economies, the returns to scale decrease.
Types of Economies and Diseconomies of scale
Types of Economies of scale
Economies of scale are of two types
(i) Internal Economies of Scale
(ii) External Economies of Scale
Types of Diseconomies of Scale
(i) Internal Diseconomies
(ii) External Diseconomies
Internal Economies of Scale
These are those which arise from the expansion of the plant size of the firm. They are specific to the individual firm. These are the unit cost advantages from expanding the scale of production in the long run. They also result in higher profits and lower prices.
Sources of Internal Economies
- Marginal Economies
- Financial Economies
- Better Utilization of Inputs
- Economies of Inventory
- Marketing Economies
- Risk Economies
(i) Marginal Economies
They arise because of the scope of employing well skilled, qualified, trained, and better employees. They help the organization to have a greater financial advantage.
They help the firm by taking quicker and better decisions. Also, they use new techniques and methods to improve management and to reduce the cost of operations.
(ii) Financial Economies
Financial economies make it cheaper to raise money. The lenders of the money decide the rate of interest. They give importance to the bigger firms. One believes that bigger firms are more creditworthy.
A firm does not only produce the needed products or services. By-products are generated in the process.
The smaller firms are not able to use these products for additional profit. A firm can sometimes sell these products or wastes to other firms to have an upper hand in earning.
(iv) Better Utilization of Inputs
Having a lot of workers and machines don’t help the firm to achieve the goal. One needs the proper knowledge to handle the machine and the techniques of their operation.
A machine can go out of order. They need maintenance and servicing. A small firm has to bear some damage when the machines go out of order. On the other hand, a bigger firm can adjust and can skip the intake of loss.
(v) Economies of Inventory
Inventories are generally the stocks of finished goods. A bigger firm can adjust the stock of products.
(vi) Marketing Economies
These are the economies of buying and selling. A bigger firm has the advantage of buying and selling in bulk.
Business in bulk reduces the cost of buying cost. The marketing departments of a firm use the professional approach for the marketing job.
The success of a firm also depends on its promotion. A company can make a financial advantage by effective use of Ads or promotion.
A smaller firm cannot afford to advertise. An advertisement all-round the year is the key to success.
(viii) Risk Economies
A big firm has better command over its resources. The risk faced by it is averaged out. The firm can compensate for the loss through the profit of another service. This is not an option for smaller firms.
Internal Diseconomies of Scale
Being a bigger firm is not always advantageous. There are some disadvantages associated also. The diseconomies are always related to the size of the firm.
Internal diseconomies imply to all factors which raise the cost of production of a particular firm. It occurs when its output increases beyond the certain limit.
Sources of Internal Diseconomies
(i) Limits of Entrepreneurship
With the increase in the size of the firm, a number of responsible members have to be appointed. The main task of them is to take the profitable on the spot decision of the ever-changing and risky situations.
This adds to the cost of operation of a firm. Moreover, there arises the communication gap between them.
(ii) Marginal Autonomy
With the increase in the size of the firm, different departments must be given the power of decision-making. This also increases the cost incurred by a firm.
Again there arises the problem of communication between them. All these add to the internal diseconomies of the firm. Inefficiency of the Employee
A firm uses the available resources in the best of the practice. However, at the ground level, there are some members who do not apply the efficient use of the resource.
They believe in their best. The firm is the second priority to them. They utilize the inefficient resource of management. This is also a diseconomy of scale for the firm.