Economies and Diseconomies of Scale

Economies of Scale

Economies of scale are the benefits or advantages that accrue to a firm by virtue of its large size. Economies are either internal or external. They include internal and external economies of scale.

Internal Economies of Scale

The internal economies of scale are the advantages or disadvantages that a firm derives from within the internal environment of the firm; they help in reducing costs of operation. Some sources or examples of internal economies of scale include:

  • Technical economies: also known as indivisibilities; may occur when a large firm is able to take advantage of an industrial process which cannot be reproduced on a small scale, for example, a blast furnace which cannot be reproduced on a small scale while retaining its efficiency.
  • Increased Dimensions:  These occur when it is possible to increase the size of the firm’s equipment and hence realize a higher volume of output without necessarily increasing the costs at the same rate.  For example, a matatu and a bus each require one driver and conductor.  The output from the bus is much higher than that from the matatu in any given period of time, and although the bus driver and conductor will earn more than their matatu counterparts, they will not earn by as many times as the bus output exceeds the matatu output, i.e. if the bus output is 3 times that of the matatu counterparts.
  • Economies of Linked Processes:  Technical economies are also sometimes gained by linking processes together, e.g. in the iron and steel industry, where iron and steel production is carried out in the same plant, thus saving both transport and fuel costs.
  • Specialisation: Specialisation of labour and machinery can lead to the production of better quality output and higher volume of output.
  • Research: A large firm will be in a better financial position to devote funds to research and improvement of its product than a small firm.
  • Marketing economies of scale: The buying advantage: A large-scale organisation may buy its materials in bulk and therefore get preferential treatment and buy at a discount more easily than a small firm.
  • The packaging advantage: It is easier to pack in bulk than in small quantities and although for a large firm the packaging costs will be higher than for small firms, they will be spread over a large volume of output and the cost per unit will be lower.
  • The selling advantage: A large-scale organisation may be able to make fuller use of sales and distribution facilities than a small-scale one. For example, a company with a large transport fleet will probably be able to ensure that they transport mainly full loads, whereas small business may have to hire transport or dispatch part loads.
  • Financial economies of scale-: A large firm will have more assets than a small firm. Hence, it will find it cheaper and easier to borrow money from financial institutions like commercial banks than a small firm.
  • Research and developmental economies.
  • Welfare economies.
  • Risk bearing economies.

External Economies of Scale

These are savings or cost advantages that come from outside the firm because a firm is located near others. They include:

  • Ready markets: I.e. availability of commercial facilities.
  • Development of good transport and communication.
  • Development of financial institutions.
  • Development of training institutions.
  • Research through pool of capital resources.
  • Development of trading associations
  • Creation of labor force which is skilled in various techniques.

Diseconomies of Scale

Diseconomies of scale are disadvantages or problems that a firm incurs as it expands and/or increases in size. The diseconomies of scale are internal or external in nature.

Internal diseconomies of scale include:

  • Managerial diseconomies: This mainly arises due to management difficulties and rising prices of inputs such as labour. Increase in development makes coordination tasks become more difficult. The firms are big so communication is problematic. Maintenance of morale is also more difficult. Control as well as implementation is extremely difficult in practice.
  • Selling / marking diseconomies
  • Labor diseconomies

External diseconomies of scale include

  • Traffic congestion.
  • Shortage of accommodation.
  • Air, water pollutions.
  • Increased price on land.
  • Increase in crime.
  • Development of slums.
  • Shortage of food.

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