There Are Two Types of Economics of Scale
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Transcript of There Are Two Types of Economics of Scale
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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.