Basic concept of economics of scale and its types

1. Dr. N. Yuvaraj
Assistant Professor
Achariya Arts and Science College
Villianur , Puducherry

2. What is economies of scale?
 Economies of scale are the cost advantages that a business
obtains due to expansion.
 When economists are talking about economies of scale, they
are usually talking about internal economies of scale.
 These are the advantages gained by an individual firm by
increasing its size i.e having larger or more plants.

4. Effects of Economies of Scale on
Production Costs
It reduces the per unit fixed cost.
As a result of increased production, the fixed cost gets
spread over more output than before.
It reduces the per unit variable costs.
Economies of scale bring down the per unit variable costs.
 This occurs as the expanded scale of production increases
the efficiency of the production process.

6. What is diseconomies of scale?
 Diseconomies of scale are the disadvantages of
being too large.
 A firm that increases its scale of operation to a
point where it encounters rising long run average
costs is said to be experiencing internal
diseconomies of scale.

7. Types of economies of scale
Internal economies of scale :- lower long run average costs
resulting from a firm growing in size.
 They refer to economies that are unique to a firm. For instance, a
firm may hold a patent over a mass production machine, which
allows it to lower its average cost of production more than other
firms in the industry.

9. External economies of scale :- lower long run average costs
resulting from an industry growing in size.
They refer to economies of scale faced by an entire industry.
 For instance, suppose the government wants to increase steel
production. In order to do so, the government announces that all
steel producers who employ more than 10,000 workers will be
given a 20% tax break.

10. Internal and external diseconomies of scale.
 Internal diseconomies of scale :-higher long run average cost
arising from a firm growing too large.
 External diseconomies of scale:- higher long run average costs
resulting from an industry growing too large .
Thus, firms employing less than 10,000 workers can potentially
lower their average cost of production by employing more
workers.
This is an example of an external economy of scale – one that
affects an entire industry or sector of the economy.

11. Types of Internal economies of scale
 Buying economies
 Selling economies
 Managerial economies
 Financial economies
 Technical economies
 Research and development economies
 Risk-bearing economies.

12. 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.

13. 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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.

19. 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.

20. Difficulty controlling the firm
 It can be hard for those managing a
large firm to supervise everything that
is happening in the business.
 Management becomes more complex and
meetings are necessary quite often.
 This can increase administrative costs
and make the firm slower in responding
to changes in marketing conditions.

21. Communication problems
 Difficult to ensure that everyone is aware about their
duties in a large firm and available opportunities like
training etc.
 The may not get a chance to exchange their views and
innovative ideas to the management team.

22. Poor industrial relations
 Higher risk for larger firms as there will be more conflicts
and diverse opinions.
 Lack of motivation of workers, strikes will be seen at
certain situations in larger firms due to poor industrial
relations.

23. External economies of scale
 A skilled labour workforce – A
firm can recruit workers who have
been trained by other firms in the
industry.
 A good reputation – An area can
gain a reputation for high quality
production.
 Specialist suppliers of raw
materials and capital goods –
When an industry becomes large
enough, it can become worthwhile
for other industries, called
subsidiary industries to set up for
providing for the needs of the
industry.

24. External economies of scale
 Specialist services – Universities
and colleges may run courses for
workers in large industries and
banks and transport firms may
provide services, specially designed
to meet the particular needs of
firms in the industry.
 Specialist markets – Some large
industries have specialist selling
places and arrangements such as
corn exchanges and insurance
markets.
 Improved infrastructure – The
growth of an industry may
encourage a govt and private sector
firms to provide better road links,
electricity supplies, build new
airports and develop dock facilities.

25. External Diseconomies of scale
 Just as a firm can grow too
large, so can an industry.
 Larger firms ->
transportation increase ->
congestion -> increased
journey time -> high
transport cost -> reduced
workers productivity.
 Growth of industry may
increase competition for
resources, pushing up the
price of key sites, capital
equipment and labour.