Economies and Diseconomies of scale (Types of internal economies of scale,…
Economies and Diseconomies of scale
Economies of scale definition
Economies of scale are the advantages, in the form of lower long run average costs, of producing on a larger scale.
Internal economies and diseconomies of scale
Internal economies of scale
When economists or entrepreneurs talk about economies of scale, they're usually referring to internal economies of scale.
Theres are the advantages gained by an individual firm by increasing its size, that is having larger or more plants.
As firm changes its scale operation, its average costs are likely to change. Average costs falls firstly, reach optimum point then rise.
In very capital intensive industry, long run average costs may fall over considerable range of output.
In other cases, average costs may fall relatively quickly to their lowest point (minimum efficient scale) and then remain constant over a large range of output. This would give:
L-Shaped LRAC curve.
Internal diseconomies of scale
Diseconomies of scale definition
Essentially, 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.
External economies and diseconomies of scale
External diseconomies of scale arise from an industry being too large, causing the firms within the industry to experience higher long run average costs.
External economies and diseconomies of scale have a different effect on a firm's LRAC.
External economics of scale: Firm's average costs will be reduced not by changes in the firm's output, but by changes in its industry's output.
In contrast, external diseconomies of scale will raise a firm's LRAC curve at each and every level of output.
Types of internal economies of scale
Best known type. Large firms buy raw materials in bulk and place large orders for capital equipment usually receiving a discount.
May also receive better treatment than smaller firms in terms of quality of the raw materials and capital equipment sold and the speed of delivery.
Due to suppliers being anxious to keep large customers.
The total cost of processing orders, packing the goods and transporting them does not rise in correlation with the number of orders.
Together, buying and selling economies of scale are sometimes referred to as marketing economies.
Large firms can afford to employ specialist staff in key posts as they can spread their pay over a high number of units.
Employing more specialist staff can increase the firm's efficiency, reduce costs of production, and raise demand and revenue.
Large firms can engage in division of labour among their other staff
The larger the output of a firm, the more viable it becomes to use large, technologically advanced machinery. These machineries are likely to be efficient, producing output at a lower average cost than small firms.
Research and development economies
A large firms can have a research and development department.
This can then reduce average costs by developing more efficient methods of production and raise total revenue by developing new products.
Risk bearing economies
Larger firms can usually produce a range of products. Enables them to spread the risk of trading. If profitability of one of products it produces falls, it can shift its resource to the production of more profitable products.
Internal diseconomies of scale
Difficulties controlling the firm
Can be hard for larger firm to supervise everything happening in the business.
A number of layers of management may be needed= More meetings.
As a result, can increase administrative costs and make the firm slower in responding to changes in market conditions.
Can be difficult to ensure that everyone in a large firm has full knowledge of their duties and available opportunities, eg: training etc.
May not get the opportunity to effectively communicate their views/ideas to management team.
Poor industrial relations
Larger firms may be at a greater risk from a lack of motivation from workers, strikes & other industrial action.
Because workers may have less sense of belonging, longer time may be required to solve problems and conflicts may arise due to presence of diverse opinions.
External economies of scale
A skilled labour force
Firm can recruit workers who've been trained by other firms in the industry.