Economies and diseconomies of scale

1. Individual Assignment
(Microeconomics Semester 2)
Name: Arvind Surwase
Roll: 027
Topic: Economies and Diseconomies of Scale

2. Economies and Diseconomies of Scale
Economies of Scale
Economiesof scale are cost advantagesreapedbycompanieswhen productionbecomesefficient.
Companiescanachieve economiesof scale byincreasingproductionandloweringcosts.Thishappens
because costsare spreadovera largernumberof goods.Costscan be bothfixedandvariable.
It isa longtermconcept.Economiesof scale are achievedwhenthere isanincrease inthe salesof an
organization.Asaresult,the savingsof the organizationincreases,whichfurtherenablesthe
organizationtoobtainrawmaterialsinbulk.Thishelpsthe organizationtoenjoydiscounts.These
benefitsare calledaseconomiesof scale.
The size of the businessgenerallymatterswhenitcomestoeconomiesof scale.The largerthe business,
the more the cost savings.Economiesof scale canbe bothinternal andexternal.Internal economiesof
scale are basedonmanagementdecisions,whileexternal oneshave todowithoutside factors.
i.Internal Economiesof scale:
Internal economiesof scale happenwhenacompanycutscosts internally,sothey're uniquetothat
particularfirm.Thismay be the resultof the sheersize of a companyor because of decisionsfromthe
firm'smanagement.Aninternal economyof scale measuresacompany'sefficiencyof production.That
efficiencyisattainedasthe companyimprovesoutputwhenthe average cost perproductdrops.

3. a. Technical economiesof scale:
In large scale production,huge andmodernmachinesare used.The machineshave lessoperational
costs andmore production.Thus,productionisincreasedwithalittle increase incosts.
b. Marketingeconomiesof scale:
These are concernedwiththe buyingof raw materialsandsellingof finishedproducts.Heavypurchases
of rawmaterialsmayreduce cost of theirsupplyandmake it possible tohave betterquality.There may
be economyinadvertisingcostsalsoastheirmarketingbudgetsare huge.
c. Financial economiesof scale:
Large firmshave a marketreputationdue totheirassetsvolume of production.Theirgoodwill helps
theminobtainingfundsinlarge volumesatalowerrate of interestandcan repayiteasilyalso.
d. Managerial economiesof scale:
Large organizationscanaffordtoemployspecializedworkersandmanagersforperformingdifferent
tasks.These workersare expertsintheirfieldsanduse theirknowledge andexperience tomaximize the
profitsof the organization.
e.Risk-bearingeconomies:
Risksinlarge firmsare dispersedoverdifferentactivitiesandvolumeof production.Diversificationof
productionmaylessenrisks.
ii.External Economiesof scale:
External economiesof scale,onthe otherhand,are achievedbecauseof externalfactors,orfactorsthat
affectan entire industry.Thatmeansnoone companycontrolscostson itsown.These occur when
there isa highly-skilledlaborpool,subsidiesand/ortax reductions,andhe is

4. partnershipsandjointventures—anythingthatcancut downon coststo many companiesinaspecific
industry.
a. Economiesof Concentration:
As an industrygrowslargerorbecomesclusteredinone location—aswith,say,the bankingand
financial servicesinNewYorkorLondon—thanthe average costsof doing businesswithinthatindustry
overthe longrun become lower,costsalsomayfall because of increasedspecialization,bettertraining
of workers,fasterinnovation,orsharedsupplierrelationships..
b. Economiesof Information:
Whenthe numberof firms in an industryexpandstheybecome mutuallydependentoneachother.In
otherwords,theydo notfeel the needof independentresearch.Whenscientificandtrade journalsare
published,these journalsprovide informationtoall the firms,whichrelate tonew market,sourcesof
raw materials,latesttechniquesof productionetc.
c. Economiesof Disintegration:
As the industrydevelops,all the firmsengagedinitdecide todivide andsub-divide the process.For
instance,incase of mopedindustry,some firms specialize inrims,hubsandstill othersinchains,pedals,
tyresetc.

5. Diseconomies of Scale
The economiesof scale cannotcontinue indefinitely.A time comesinthe life of afirmor an industry
whenfurtherexpansionleadstodiseconomiesinplace of economiesi.e.longrunaverage costsof the
organizationincreases.Internalandexternal diseconomiesare,infact,the limitstolarge scale
productionwhichare discussedbelow.
i.Internal diseconomiesofscale:
Internal diseconomiesof scale involve eithertechnical constraintsonthe productionprocessthatthe
firmusesor organizational issuesthatincrease costsorwaste resourceswithoutanychange tothe
physical productionprocess.
a. InefficientManagement:
The main reasonof the internal diseconomiesisthe lackof efficientorskilledmanagement.Whenafirm
expandsbeyondacertainlimit,itbecomesdifficultforthe managerto manage itefficientlyortoco-
ordinate differentprocessesof production.Itadverselyaffectsthe operationalefficiency.
b. Technical Diseconomies:
Anothermajorreasonforthe onsetof internal diseconomiesisthe emergenceof technical difficulties.
In everyfirm,there isanoptimumpointof technical economies.If afirmoperatesbeyondthese limits,
technical diseconomieswill emerge.Forinstance,if anelectricitygeneratingplanthasthe optimum
capacityof 1 millionSmallscale andlarge scale production.Kilowattsof power,itwill have lowestcost
perunitwhenit produces1 millionKilowatts.Beyond the optimumpoint,technicaleconomieswillstop
and technical diseconomieswill result.

6. ii.External diseconomies ofscale:
External diseconomiesof scale canresultfromconstraintsof economicresourcesorotherconstraints
imposedona firmor industrybythe external environmentwithinwhichitoperates.
External diseconomiesare notsufferedbyasingle firmbutbyall the firmsoperatingina givenindustry
whichraise the cost of production.These diseconomiesarise due tomuchconcentrationand
localizationof industriesbeyondacertainstage.Localizationleadstoincreaseddemandfortransport
and,therefore,transportcostsrise.
Similarly,asthe industryexpands,thereiscompetitionamongfirmsforthe factorsof productionand
the raw-materials.Thisraisesthe pricesof raw-materialsandotherfactorsof production.Expansionof
an industrymayalsoraise the wagesof skilledlabourwhichare inshortsupply.Asa resultof all these
factors,external diseconomiesbecome more powerful.