What are Economies and Diseconomies of Scale?
Economies of scale may be defined as the cost advantages that can be achieved by an organisation by the expansion of their production in the long run. Therefore, the advantages of large scale expansion are known as Economies of Scale. The lower average cost per unit achieves the advantage in cost.
Economies of Scale are a long term concept that is achieved when there is an increase in the sales of an organisation. Due to the lowering of production cost, the organisation can save more and invest it in buying a bulk of raw materials which can again be obtained at a discount.
These are the benefits of Economies of Scale. When there is a massive expansion in an organisation, the cost per unit may increase with the increase in output. Diseconomies of Scale may arise due to internal issues resulting from technical, organisational, or resource constraints.
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Types of Economies of Scale
The Economies of Scale may be divided into two categories-
1) Internal Economies
2) External Economies.
Internal Economies: Internal Economies are the real economies that arise from the expansion of the organisation. These economies are the result of the growth of the organisation itself.
External Economics: External Economics are the economies that originate from factors outside the organisation. These economies result in the increase in the main organisation by the increase in the quality of factors outside the organisation like better transportation, better labour, infrastructure, etc. Due to the betterment of these external factors, the cost of production per unit of an item in the organisation decreases.
Types of Diseconomies of Scale
Similar to the Economies of Scale, Diseconomies of Scale is of two types- Internal Diseconomies of Scale and External Diseconomies of Scale.
Internal Diseconomies of Scale: Internal Diseconomies of Scale are the Diseconomies resulting from the internal difficulties within the organisation. The Internal Diseconomies are the factors that raise the cost of production of an organisation like lack of supervision, lack of management and technical difficulties.
External Diseconomies of Scale: External Diseconomies of Scale are the external factors that result in the increase in the production per unit of a product within an organisation. The external factors that act as a restrain to expansion may include the cost of production per unit, scarcity of raw materials, and low availability of skilled labours.
Solved Examples
Q1. What are the Factors which differ between Internal and External Economies of Scale?
Answer: Economies of Scale are of two types, namely Internal and External Economies of Scale. Internal Economies of Scale originate from internal factors within the organisation. The Internal Economies of Scale are the internal factors that can be controlled by the organisation to lower the cost of production.
On the other hand, External Economies of Scale are the external factors that affect the cost of production per unit. The External Economies of Scale are the factors that reduce the cost of production. Unlike internal Economies of Scale, the External Economies of scale cannot be controlled by the organisation. They include factors like the availability of highly skilled labour, tax reductions, partnerships, etc. any factor that can reduce the cost of production per unit.
Examples of Internal Economies
Technical Economies of Scale: This occurs when an organisation invests in modern technology which helps in lowering the cost of production. It enables an organisation to produce a large number of goods in a lesser period.
Financial Economies of Scale: This occurs when large organisations take a loan with a low rate of interest. The banks easily give them loans since they have good credibility.
Managerial Economies of Scale: This occurs when large organisations employ people with a special skill set that helps to maximize the profits of the organisation like an accountant or manager.
Marketing Economies of Scale: This occurs when large organisations increase their budget. They can then spread their market by setting up branches or buying more raw materials in bulk at a lower price.
Cournot Dilemma
It has also highlighted that in several industrial areas there exist several enterprises with varying sizes and organizational structures. This conflict, among the actual data and the conceptual opposition among economies of scale and competitiveness, has been termed the ‘Cournot dilemma’. Whereas the study is expanded, including the issues involving the growth of information and the structuring of interactions, it is possible to infer that economies of scale do not necessarily result in dominance. In reality, the comparative benefits resulting from the growth of the firm's competencies and from the administration of dealings with suppliers and consumers might offset those supplied by the scale. Thereby it neutralizes the inclination to a monopoly implicit in economies of scale.
In other words, the variability of the organizational forms and of the size of the firms functioning in a field of business can be decided by variables concerning the reliability of the goods, the manufacturing flexibility, the contractual methods, the educational opportunities, the heterogeneity of choices of clients who convey a distinguishable requirement with respect to the reliability of the product, and aid before and after the sale. Such as, for instance, flexible production on a large scale, small-scale adaptable production, mass production, industrial production predicated on strict technologies affiliated with flexible organizational systems and related artisan production.
Solutions to Diseconomies of Scale
Approaches to the diseconomies of scale for large organizations may entail separating the corporation into smaller groups. This can either occur by consequence when the firm is in financial problems, sells off its successful sections, or closes down the remainder. It can also happen intentionally if the management is willing. To prevent the adverse consequences of diseconomies of scale, a business must keep to the lowest average production cost. It must strive to detect any external diseconomies of scale. Furthermore, on obtaining the lowest average cost, a business must either extend to other nations to generate demand for its products or explore new markets or manufacture new items that do not conflict with its original products. Nevertheless, neither of these activities would definitely eradicate connectivity and management challenges commonly associated with huge firms.
A comprehensive examination and redesign of business operations, in order to minimize complication, can offset diseconomies of scale. This allows for greater productivity. Better management systems and more effective supervision of labour and activities can decrease costs.
FAQs on Economies and Diseconomies of Scale in Production
1. What is meant by economies and diseconomies of scale?
Economies and diseconomies of scale describe how a firm's costs change as it grows larger. Economies of scale occur when increasing production reduces the average cost per unit, making output cheaper as the business expands. In contrast, diseconomies of scale happen when continued growth causes the average cost per unit to rise due to inefficiencies. These opposing effects influence how big a firm should grow. Understanding this balance is crucial for companies aiming to maximize profit and efficiency while minimizing waste as they expand.
2. What are examples of diseconomies of scale in economics?
Diseconomies of scale occur when a firm grows too large, leading to higher average costs. These can arise for various reasons. Common examples include:
- Communication breakdowns as organizations become more complex
- Lower employee motivation due to lack of personal connection
- Bureaucratic delays that slow down decision-making
- Difficulty in coordinating production across multiple locations
3. What is the best explanation for diseconomies of scale?
Diseconomies of scale describe the increase in average costs that can happen when a company becomes too large. This rise is mainly due to factors like inefficient management, difficulty communicating across departments, or complex processes. As the scale of operations expands beyond a certain point, these challenges lead to wasted resources and higher per-unit costs. In summary, diseconomies of scale are the negative side of growth, highlighting that expanding too much can hurt a firm's cost-effectiveness and productivity.
4. What is economies of scale in simple terms?
Economies of scale mean that as a business increases its production, the average cost for each product goes down. This happens because fixed costs, like rent or machinery, get spread over more units. It can also result from buying materials in bulk or specialized labor. In short, economies of scale help larger companies produce more at a lower average cost, making them more competitive in the market.
5. What are the types of economies of scale?
Businesses can benefit from different types of economies of scale, depending on where their cost savings come from. The main types include:
- Internal economies of scale: Cost savings generated inside the company, such as technical improvements, specialized workers, or better financial deals
- External economies of scale: Advantages gained from the growth of the industry as a whole, like shared suppliers or a skilled workforce nearby
6. How do firms achieve economies of scale?
Firms can achieve economies of scale by increasing their output and making internal operations more efficient. This is often possible through:
- Investing in advanced technology to produce more with fewer resources
- Specializing workers and tasks for greater productivity
- Negotiating bulk purchases for discounts on raw materials
- Spreading fixed costs over a larger number of units
7. Why do diseconomies of scale occur as a firm grows?
As firms grow, diseconomies of scale can emerge due to several challenges. Complex structures and more employees often hinder communication and management oversight. Additionally, bureaucratic processes can delay decisions and lower morale among staff. These factors collectively increase average costs and reduce efficiency as firms expand beyond an optimal size. Recognizing these risks is essential for maintaining sustainable growth while managing business scale.
8. What is the difference between internal and external economies of scale?
Internal and external economies of scale both help reduce costs, but they work differently. Internal economies come from within the firm, such as better technology, skilled labor, or efficient resource use. In contrast, external economies arise from the industry's growth, like improved infrastructure or shared suppliers in the region. Both types lead to lower average costs, but the source of the savings distinguishes them. Firms can benefit from both as they expand.
9. Can you give real-life examples of economies of scale?
Many large organizations benefit from economies of scale in the real world. For instance, automobile manufacturers can purchase parts in bulk at lower prices, and large supermarkets can spread operating costs across thousands of products. Tech companies may invest in expensive equipment once, but use it to serve millions of customers. These examples show how increasing production or size can lower average costs and make companies more efficient, which helps them succeed in competitive markets.
10. How do diseconomies of scale impact business growth and profits?
Diseconomies of scale can negatively affect business growth and profits by pushing up average costs as a company expands beyond its optimal size. When coordination becomes difficult or decision-making slows down, productivity drops and costs increase. As a result, profit margins may shrink, and the business could lose its competitive edge. Managing scale is essential, as unchecked growth can decrease efficiency and hurt overall financial performance.
