Economies and Diseconomies of Scale
Economies and Diseconomies of Scale
Economies of scale are defined as the benefits that a firm can achieve by expanding its scale of production in the long run. When the firm increase its production on a large scale, it helps to reduce the production cost and establish an optimum size of a firm. There are two types of economies:
Internal Economies
External Economies
1-Internal
Economies: The internal
economies arise within a firm itself when it increases the scale of production.
There are the following types of internal economies of scale:
Technical Economies- These economies arise because of technological improvements and the use of modern techniques of production. When a firm increases the scale of production, it becomes easy to
take the mechanical advantage of the use of a large machine. Large machines are
more productive and use proportionately less energy. Large scale reduces the
cost of production by adopting the latest inventory management techniques.
It is also possible that
different firm join their hands together and derive the benefits of linked
processes.
A firm can invest adequately
funds for research and get the benefit of it.
Managerial Economies-
These economies arise because of the efficient and
scientific management of a firm. In the large-scale production, the manager of
the firm delegates some of his functions to trained and specialized employees
and confines himself to coordinating, planning, and executing the plans. This
would lead to higher efficiency and a reduction in the cost of production.
Commercial Economies-
It arises from the purchase of materials and
sale of goods. A large firm can buy raw materials and other inputs in bulk at
discounted rates because of their good-bargaining-capacity. Apart it, they are
able to secure concessions from transport, cheap credit from the banks, prompt
delivery, careful attention from all dealers. It can follow effective sales promotion
policy to influence the consumers of its products.
Financial
Economies- A large firm has
better credit and can borrow on more favorable terms. It can mobilize huge
funds from money market and financial institutions at concessional interest
rates. A large firm can float debentures and issue shares to raise the funds. Thus
a big firm can secure sufficient funds more easily comparatively to smaller
firms.
Labor Economies- In a large firm, there is a sufficient scope
for division of labor. A large firm may spend a lot of money on the training of
their employees in order to raise their skills, efficiency and productivity. Specialized
labor produces a larger output with better quality.
Risk-bearing
Economies: A big firm can
often eliminate the risks by the diversification of output, market and source
of supply. A big firm can produce multiple products, so that if there is a loss
in one product, it can compensate by making the profits in other goods. A large
firm spreads the market by selling its products in different markets and can
purchase the raw materials and other inputs from the different sources.
2- External
Economies: External economies are those economies which arise
to the firms as a result of the overall
growth of an industry. Various types of external economies are given below:
Economies of concentration:
It arises because of localization of industry.
All the firms can get better, trained and skilled labor at a reasonable rate,
cheap transport and communication, power, raw materials, etc, due to
localization of industry. It helps in reducing the cost of production.
Economies of
Information: When a large number
of firms are located in a region, it becomes possible for them to exchange
their views frequently and organize workshops, seminars on the topics of mutual
interest. It strengthens inter-firm relationships and helps in economizing the
expenditure. All the firms can get the benefits from the publication of
trade, technical generals and central research institutions.
Economies of
Disintegration: When an industry
grows beyond the limit, it becomes necessary to split up some of the processes
which are taken over by specialist firms, and economies arise due to this
disintegration . For example, in a cotton industry, few firms may get
specialization in manufacturing threads, others making cloths, and some others
dying and coloring, etc. This type of disintegration increases the efficiency
of the firms and reduces the cost.
Economies of
Government Action: It arises when the
government supports the private sector units by granting tax concessions, tax
exemptions, subsides, rebates, financial assistance at low interest in order to
encourage the development of private industries.
Economies of
Welfare: When an industry provides
welfare facilities to the workers by setting up housing colonies for the
workers, establishing healthcare units, training centers and educational
institutions. It helps in raising the efficiency and productivity of workers.
Diseconomies of Scale
When a firm expands beyond the
optimum limit, economies of scale will be converted into diseconomies of scale.
Some of these diseconomies are as follows:
Overworked
Management: A manager in the
large scale firm can not pay full attention to each detail due to the loss of
effective supervision, control and coordination of factors of production and it
leads to all kinds of wastage, indiscipline and rise in production costs.
Financial
Diseconomies: Excess growth of
the firm requires big amounts of finance which may not be available to the firm
and it has to pay higher interest rates for additional funds and it will increase
the cost.
Market
Diseconomies: Large scale of
production may result in over-production because of the mismatch between demand
and supply of goods and it leads to fall in price and profits.
Technical
Diseconomies: There is a limit for
division of labor and specialization. Beyond a point they become negative and
per unit cost will certainly go up.
Labor Diseconomies:
When a firm expands the scale beyond the
optimum point, industrial disputes may arise because of mismanagement. Labor
unions may not cooperate with the management and demand higher wages and other
benefits. It may contribute to higher production cost.
Lack of
Adaptability: A large scale firm finds
it very difficult to switch on from one business to another.
Cut-Throat
Competition: Many firms
sometimes are ruined by senseless competitions.
International Complications:
When the large scale firms operate on an
international scale, there interests clash either on the score of markets or of
materials and sometimes these complications may lead to many conflicts.
Thus, Economics of Scales
provides information about the various benefits when the firm goes for large
scale production. While diseconomies of scale shows the certain limitations of
expansion in output.
Very nice lecture
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