Economic Analysis

Module 4. Concepts of costs

Lesson 18
ECONOMIES AND DIS ECONOMIES OF SCALE

18.1 Introduction

Large scale Production is profitable due to economics of scale. Economics of scale is defined as ' Any aspect of production which reduces average cost of production in the long run as output increases.' Economies of scale occurs upto a certain expansion limit of the firm. If the firm becomes too large that it is difficult to manage it efficiently, then dis economies of scale occur.

18.2 Economies of Scale

Economics of scale is measured in money terms and is of two types (a) Internal (b) External. Internal economics are realized independently by individual firms as they expand irrespective of other firms. External economics is shared by all the firms when its size expands. In reality both internal and external economics overlap.

18.2.1 Forms of internal economies

Different forms of internal economics are

1. Labour Economies : Due to expansion of firm, division of labour with more specialization occurs. A big firm can also attract efficient labour due to better carrier advancement opportunities. In large firms, skill, efficiency and productivity of labour decreases the cost per unit of output and lead to labour economics.

2. Technological Economies : This economics occur in a large firm due to use of superior technology, mechanical advantage of using large machines, continuous processes, and economics in power consumption and use of by products.

3. Managerial Economies : Due to indivisibility of functions of managers, the cost per unit of management decreases as output increases. It is possible to recruit proficient managers by large firms leading to increase in efficiency.

4. Marketing Economies : This occurs due to purchase of large quantity of raw materials at low cost and distributing larger quantity of finished products leading to reduced distribution cost.

5. Financial Economies : It is possible to raise finance through shares as well as get requisite finance from banks and other financial institutions at lower interest rate.

6. Risk Minimizing Economies : A Large firm can reduce the risk of diversification of output, by diversification of market, by diversification of sources of supply as well as process of manufacturing.

18.2.2 Forms of external economies

Different forms of external economics are

1. Economies of localization: This is obtained in the form of availability of skilled labour, better transport facilities and availability of other infrastructure facilities at reduced rate.

2. Economies due to Common Research Output: It is possible to carry out a common research experiments so as to reduce the cost. The results can be used by all the partner organization.

3. Economies of Vertical Disintegration: With expansion of industry there will be growth of other subsidiary industries to supply inputs at reduced rate.

4. Economies of Byproducts: With superior technology and new research breakthrough it is possible to convert waste materials into byproducts leading to more profit.

18.3 Diseconomies of Scale

Economics of scale occurs upto a certain expansion limit of the firm. If the firm becomes too large that it is difficult to manage it efficiently, then diseconomies of scale occur.

This occurs due to difficulty in managing, co-ordination and decision making by managers. There is delay in decision making. There is also possibility of increased risk and even scarcity of common factor inputs due to increased competition. For a very large firm financial and marketing diseconomies also can occur due to difficulty in obtaining required amount of finance and not able to market their products to diverse markets as needs of each market will be different.

Economies of scale occur up to a certain expansion limit of the firm. If the firm becomes too large that it is difficult to manage it efficiently then diseconomies of scale occur.

Fig 18.1 Economies and diseconomies of scale