ECONOMIES OF SCALE

Definition of Economies of Scale

Economies means advantages and Scale refers to the size of unit. When the producer starts producing on a
large scale in the long run he starts getting some economies as well as some diseconomies of scale.
The scale of production means the size of the production of a firm. The scale of production can vary from small to
large depending upon the quantity of output per unit of time of the firm.
An important feature of production in the modern industrial economy in that production takes place on a large
scale. This leads to reduction in the cost of production. The low cost is a result of what is called ECONOMIES OF
SCALE.

Concept of Economies of Scale: The concept of ECONOMIES OF SCALE can be understood in two senses: Broad
Concept & Narrow Concept.

Broad Concept: Anything which services to minimize average cost of production in the long run as the scale of output
increases is referred to as ECONOMIES OF SCALE.
Narrow Concept: ECONOMIES OF SCALE refers to the characteristics of the production process by which
average productivity is enhanced with the expanding scale of output.

Classification of Economies of Scale in to two types as:
1. Internal Economies of Scale.
2. External Economies of Scale.

1. Internal Economies of Scale: Internal economies are those advantages which are enjoyed by individual
firm when its size expands. They depend primarily on the size of a firm. These are enjoyed by individual firm
when its scale of production increases, independently of the action of other firms.

Types of Internal Economies of Scale:
1. Labour Economies.
2. Managerial Economies.
3. Marketing of Economies.
4. Financial Economies.
5. Technical Economies.
6. Risk-Bearing Economies.

LABOUR
As scale of production expands division of labour possible.
With the division od labour specialization of the labour improves
Managerial economics
In a large firm every department such as marketing, finance, administration etc have professional managers.
This increases the operation efficiency and reduces the cost.
marketing
A large firm enjoys economies in purchasing few raw materials and selling its finish products.
It has better bargaining power and hence it can purchase raw materials in bulk and can get discount over it.
Financial
A large firm can get finance easily.
Large firms have better creditability.
Large firms are considered less risky by banks and financial institution.
technical
A large firm can minimize the cost of manufacturing of the product by getting improved machinery and
technology.
Large firm can it economical to produce or manufacture parts or components rather than buying them from other
sources.

Risk bearing
A large firm can minimize the risk of business.
The diversification of products, diversification of markets, diversification of methods of production etc.

External Economies of Scale.
External Economies means the benefits accruing to all the firms in an industry from the growth of that industry.
External economies are enjoyed by all the firms in the industry, irrespective of their size. External economies arise when
the industry is localized in a particular area all the advantages of localization are enjoyed by the firms in that industry.

Types of External Economies of Scale:
1. Economies of Localization.
2. Economies of Information.
3. Economies of By-Products.
4. Development of Transportation and Marketing Facilities.

Economies of Localization.
When economies of firm are located in a single area they get the benefit of cheap power raw materials, transport,
banking, research facilities etc.
All these advantages help to reduce the cost of production.
Economies of Information.
In a large industry research work is done jointly.
Market information becomes more readily available to all the firms growing in the industry.
Economies of By-Products.
In a large industry wastage can be reused to produce by products.
The firms will get some extra income and this will lead to lessening in cost of production.
Development of Transportation and Marketing Facilities.
Expansion of industry may make possible to the development of transportation and marketing facilities.
That reduces the cost of production.
Diseconomies of Scale.
When the firm expands beyond a certain limit, it leads to higher cost per unit. A rise is cost due to larger output is
called DISECOOMIES OF SCALE
The following are two types of diseconomies of scale:
Internal Diseconomies.
External Diseconomies.
Internal Diseconomies
Internal diseconomies refer to the disadvantages experienced by the firm. This enables the firm to produce less
efficiently at the same levels of output. Such disadvantages arises from with in the firm s such as:
1. Technical Diseconomies.
2. Risk Taking.
3. Administrative Diseconomies.
4. Managerial Diseconomies
5. Labour Diseconomies.
Technical Diseconomies.
If production is increased beyond the optimum point diseconomies arise.
So it leads to high cost of maintenance and heavy losses in case of break down.
Risk taking
Large firms are exposed to risk than the smaller firms due to large scale of operations.
In large firms strike, lockout, layoff are more.
Administrative Diseconomies.
Administrative becomes very difficult when an organization becomes very large.
There emerge difficulties of coordination, designs making etc.
Managerial Diseconomies
When the scale of production becomes very large, supervision and management become very difficult.
Labor Diseconomies.
When the number of labours become very large it causes less contact between the labour and management.
This results in labour unrest, industrial disputes, and misunderstanding between labour and management.

External Diseconomies
As an industry expands, external diseconomies arise due to increase in factor price. External diseconomies refer to
the disadvantages experienced by the firm and industry to external factors such as:
1. Intense competition among the firms raises the price of raw material and the factor of production.
2. When many firms are located in a particular area, there will be considerable pressure on transport system.
3. Expansion of an industry in a particular area will lead to higher rent and high cost.
4. Management and co-ordination becomes difficult.
5. Scarcity of electricity, water, finance, technical labour raises the price.
Pollution of rivers and lakes creates external diseconomies.


Types of Internal economies of scale.
1. Buying economies
2. Selling economies
3. Managerial economies
4. Financial economies
5. Technical economies
6. Research and development economies
7. Risk-bearing economies.

Buying Economies.
These are the best known type. Large firms that buy raw materials in bulk and place large orders for capital
equipment usually receive a discount. This means that they have paid less for each item purchased. They may
receive a better treatment because the suppliers will be anxious to keep such large customers.
Selling Economies.
Every part of marketing has a cost particularly promotional methods such as advertising and running a sales
force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of
marketing over a wider range of products and sales cutting the average marketing cost per unit.
Managerial Economies.
As a firm grows, there is greater potential for managers to specialize in particular tasks (e.g. marketing, human
resource management, finance). Specialist managers are likely to be more efficient as they possess a high level of
expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these
roles.
Financial economies
Many small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is often
quite high. This is because small businesses are perceived as being riskier than larger businesses that have
developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at
lower interest rates.
Technical Economies.
Businesses with large-scale production can use more advanced machinery (or use existing machinery more
efficiently). This may include using mass production techniques, which are a more efficient form of production. A
larger firm can also afford to invest more in research and development.
Research and development economies.
A large firm can have a Research and Development department, since running such a department can reduce
average costs by developing more efficient methods of production and raise total revenue by developing new
products.
Risk-bearing economies.
Larger firms produce a range of products. This enables them to spread the risks of trading. If the profitability of
one of the products it produces falls, it can shift its resources to the production of more profitable products.

Internal Diseconomies of scale.
Growing beyond a certain output can cause a firms average costs to rise. This is because the firm may encounter a
number of problems including difficulties :-
controlling the firm.
communication problems.
poor industrial relations.