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INTERNAL ECONOMIES

and DISECONOMIES

OF SCALE

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INTERNAL ECONOMIES OF SCALE

• They are benefits that accrue to A SINGLE FIRM as it expands.

• They cause a reduction in the firm’s average cost of production as output increases.

• Some of the sub-types are:Technical Economies; Managerial Economies;Financial Economies; Risk Bearing Economies;Research Economies; Marketing Economies;Commercial Economies.

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INTERNAL DISECONOMIES OF SCALE

• They are problems which are experienced by A SINGLE FIRM as it expands production beyond a particular limit.

The over-expansion of a firm’s output would lead to rise in costs and thus covert economies into diseconomies.

This occurs due to factors like: fixed factor fatigue and / or breakdown; and possible use of inferior or less efficient inputs, due to a

lack of sufficient better quality inputs.

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INTERNAL TECHNICAL ECONOMIES OF SCALE

• An expanding firm can afford to use superior technology (like modern machinery) to reduce its costs and thereby develop a competitive edge over its rivals.

• Consider:Machine ‘A’ can produce 10,000 chocolates a day, Machine ‘B’ can produce 1,000 chocolates a day;

But Machine ‘A’ does not require ten times the supporting factors as Machine ‘B’

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INTERNAL TECHNICAL DISECONOMIES OF SCALE

• Technology is continuously up-graded.

• Firms cannot constantly change technologies, as they have currently invested heavily in superior technology (like modern machinery).

• If rival firms up-grade technology, the firm under consideration may not be able to retain and / or increase its market share.

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INTERNAL MANAGERIAL ECONOMIES OF SCALE

• They arise from a firm’s specialization and mechanization of its management strategies, as it expands it’s scale of production or operations.

• Small Firm Manager = Foreman = Worker

wastes time on small jobs

(eg., Grade II Hotel Manager)• Large Firm specialized management cadres

task delegation saves time

improves efficiency …..

(eg., a Five-Star Hotel has Managers for various activities)

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INTERNAL MANAGERIAL DISECONOMIES OF SCALE

• As production or operation scale increases, the management cadre is overworked.

• Managers become unable to supervise efficiently.

• Due to laxity of control cost increases.

• Illustration, a very able teacher may not be able to deliver efficiently if the class size is beyond a particular strength.

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INTERNAL FINANCIAL ECONOMIES OF SCALE

• Big firms have more credible and so investors are ready to trust their monies with them.

• As a firm’s operations level increases, larger financial resources are available to it at lower costs.

• For instance: Companies like Tata, Reliance, Birla are more

credible than smaller firms and so investors offer the required finances at reasonable rates.

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INTERNAL FINANCIAL DISECONOMIES OF SCALE

• Big firms can misuse their financial credibility.• They can become heavily indebted. • They can misuse the funds at their disposal.

• As the debt component increases, the firm’s debt-servicing expenditures also increase.

• Recall: The recent Satyam scandal in India and the

financial imprudence displayed by some large firms that led to the current recession.

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INTERNAL MARKETING ECONOMIES OF SCALE

• When a firm increases it’s scale of operations, it can indulge in mass marketing strategies and thus reduce its per unit selling costs.

• Big firms can hire the best advertising companies, own or hire warehousing facilities and use modern transportation facilities.

• eg., AMUL’s beverage marketing campaign is far more expensive and impacting than a small beverage firm which has limited commercial influence.

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INTERNAL MARKETING DISECONOMIES OF SCALE

• Very large firms can indulge in excessive marketing outlays and this could cause their overall costs to increase and so their prices rise.

• They concentrate more on out-beating each other in sales and may not concentrate on improving manufacturing strategies or product quality.

• The Coke – Pepsi commercial war is a case in point.

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INTERNAL RISK-BEARING ECONOMIES OF SCALE

• An expanding firm can diversify its output taking on as well as eliminating risks impacts strength and stability.

• If one product of the firm is not faring well, its other products can provide the finances to tide over.

• Hindustan Unilever Ltd. simultaneously markets Lux soaps, Pepsodent and Close Up, Lipton Tea, Sunsilk and Dove shampoos, Vim soap, Surf and so on. Thus, HUL can cover business risks far better than a smaller firm like Nirma

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INTERNAL RISK BEARING DISECONOMIES OF SCALE

• As a firm expands and diversifies its output, it could end up having too many unsold outdated products with it.

• It will thus lose its competitive edge and consequently its market share will reduce.

• TATA is now shedding-off its non-core competence commodities to improve its concentration on a few commodities to enhance its market status even further.

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INTERNAL LABOUR ECONOMIES OF SCALE

• As firm’s scale increases division of labour and specialization takes place improves speed, skill, dexterity more output per unit input

• e. g. Garment industry: Small scale vs. Large scale

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INTERNAL LABOUR DISECONOMIES OF SCALE

• As the firm increases its size its labour force requirement increases unionization of labour more labour demands and even agitations.

• The problem of disguised unemployment emerges.

• Ultimately firm’s costs increase and market share falls.

• Some Indian Public Sector Undertakings are facing such situations even today.

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INTERNAL RESEARCH ECONOMIES OF SCALE

• Big firms can afford to have its own R & D Departments.• They develop new products & methods of production.• Thus, they gain a cutting edge in the market.

• Firms like Ranbaxy, Infosys, Sony can be cited as examples of firms indulging in the cost-cutting strategy of in-house R & D.

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INTERNAL COMMERCIAL ECONOMIES OF SCALE

• Large firms get advantages in the purchase of raw materials and in the sale of goods as they have:• Bargaining advantages when buying / selling in bulk,• Prompt delivery, careful attention from dealers.

Instances:• Cadbury buys cocoa, milk, sugar etc. in bulk at

discounted prices, or, • SAIL guarantees its customer-firms prompt delivery.

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INTERNAL COMMERCIAL DISECONOMIES OF SCALE

• Individual consumer’s tastes ignored due to:• mass production or standardized production. • eg., Classic Henry Ford Quote on Car color

• Production lacks personal touch:• Big businesses are generally managed by

paid employees. The personal touch needed in industrial relations are missing. Hence, labour-Management tensions build up.

• Compare the consumer-friendly approach in a local Grocery shop and in a massive retail mall.

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OUTPUT

AVERAGE COST Impact on short run Average Cost

(AC)

Internal EoSInternal DoS

Optimum level of production

AC curve

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EXTERNAL ECONOMIES

and DISECONOMIES

OF SCALE

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• They are those advantages which accrue to each member-firm as THE INDUSTRY grows.

• They accrue due to factors outside the influence of a single firm.

• They lead to decreasing long run average costs for firms within the industry.

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EXTERNAL ECONOMIES OF SCALE

These are advantages of a localized industry; they include:• Availability of skilled labour, • Better transport and credit facilities, • Benefits from subsidiary. • Sharing of common stock of knowledge and

experience.

• Scattered firms cannot enjoy such economies.

• Example : Growth of Bangalore as an IT hub.

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ECONOMIES OF CONCENTRATION

These economies include:• Publication of trade and technical journals. • Drawing of research results from common central

pool of research institutions.

• Firms in a scattered industry cannot have such facilities.

• Example: The story of the growth of the Silicon Valley in the USA

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ECONOMIES OF INFORMATION

• When an industry grows it become possible to split up some of the processes which are taken over by specialized firms.

• They can enjoy internal economies of scale and thereby produce efficiently and at lowered costs.

• Example: Growth of the Electronic Industry.Different firms specialize in the production of components, through the outsourcing strategy

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ECONOMIES OF DISINTEGRATION

EXTERNAL DISECONOMIES OF SCALE

• They are those disadvantages which accrue to each

member-firm as THE INDUSTRY grows.

• They accrue due to factors outside the influence of a single firm.

• They lead to increasing long run average costs for firms within the industry.

When an industry expands: • Intensification of competition among firms for

limited resources cost of production increases.

• Housing becomes scarce and so expensive and unaffordable for many the mushrooming of slums and other informal housing facilities.

• Traffic jams are frequent, causing the pollution problem to get aggravated

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EXTERNAL DISECONOMIES OF SCALE

Production requires private costs that can damage the surroundings, but …. ….. the firms involved do not pay for the resultant social costs.

•An upstream pulp mill discharges effluents in the river reduces the scope for fishing poses an externality to the fishing industry.

•Steel factory produces smoke health problems of people in neighbouring areas

•nuclear plants radioactive atmosphere.

•The death of the Mithi River in Mumbai, is a case in point.

EXTERNAL ENVIRONMENTAL DISECONOMIES

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Production requires private costs that can damage the surroundings, but …. ….. the firms involved do not pay for the resultant social costs.

•An upstream pulp mill discharges effluents in the river reduces the scope for fishing poses an externality to the fishing industry.

•Steel factory produces smoke health problems of people in neighbouring areas nuclear plants radioactive atmosphere.

•The death of the Mithi River in Mumbai, is a case in point.

EXTERNAL ENVIRONMENTAL DISECONOMIES

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IRS CRSDRS

LONG RUN AVERAGE COST

OUTPUT

AVERAGE COST

O

LAC 1

LAC 2

Ex DisEco

Ex Eco

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Bibliography

1. Ammer & Ammer, Dictionary of Business and Economics2. Collins Reference, Dictionary of Economics3. Dwett, Modern Economic Theory, 4. Hansen, A Dictionary of Economics and Commerce5. International Encyclopedia of Social Sciences (Vol 4)6. Lipsey, An Introduction into Positive Economics7. Mansfield, Microeconomics8. Marshall, A, Principles of Economics9. McGraw-Hill, Dictionary of Modern Economics10. Mukherjee, S, Modern Economic Theory (3rd Edition)11. Palgrave Dictionary of Economics (Vol 2)12. Pearce, The Dictionary of Modern Economics13. Samuelson, Economics (11th Edition)14. Taylor, A New Dictionary of Economics15. Whitehead, G, Economics Made Simple

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