Economies and Diseconomies of Scale

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

1. What is a bottleneck?

A bottleneck is a congestion point in an organization when there is too much workload and the efficiency of the workers or the number of workers is insufficient. Due to a bottleneck, the time and expense of the production per unit increase sharply. Companies that have just started the production of something new are at a greater risk of a bottleneck since they do not have enough skilled laborers. A bottleneck also occurs when there is an unexpected increase in the demand for a certain product. It results in excess workload, less availability of raw materials and lack of skilled laborers.

2. What are the causes of the Diseconomies of Scale? 

The causes of Diseconomies of Scale are cited below. Poor communication: If the goals of production and the objectives are not properly communicated to the employees, it leads to over or underproduction which may cause a Diseconomy of Scale. Due to lack of communication, there is no feedback given to the employees which is critical to their efficiency. Poor Management Skills: In a gigantic organization, it becomes difficult to manage all the sectors of the organization. It is harder to make all the employees work towards the same goal in large organizations.

 

Cannibalization: It is a situation that arises in large organizations and produces a wide variety of products. It is seen that one product of the organization acts as a competition for another product in the same organization. Hence there is internal competition between two products from the same market which results in Diseconomies of Sale.

3. What are economies of scale in the history of economic analysis?

The first systematic analysis of the benefits of the division of work proficient of producing economies of scale, both in a static and dynamic context, was enclosed in the famous First Book of Wealth of Nations (1776) written by Adam Smith. Usually regarded as the founder of the political-economic system as an independent restraint. John Stuart Mill, in Chapter ninth of the First Book of his Concepts. It was alluding to the work of Charles Babbage on the economics of machines and manufactories. It comprehensively investigates the linkages involving growing profits and the size of output all inside the production unit.

4. What was the criticism faced by diseconomies of scale?

The empirical validity of diseconomies of scale as a general guideline has been disputed in current history, after the rising centralization of multinational firms on the worldwide level. The Cambridge economist Peter Nolan determined that in nearly all global production sectors, globalized companies had combined and concentrated as of the 1980s rather than falling victim to diseconomies of scale. This leads to significant market power intensity and oligopolistic contestability on the global level.  This condemnation implies that previous worries on diseconomies of scale, e.g. voiced by Alfred Marshall, are increasingly invalid. As improvements to global supply chains, communication technology, and decrease of transportation cost allow benefits of scale to trump diseconomies of scale.

5. What is meant by returns to scale? 

Economies of scale are connected to and may readily be mistaken with the academic economic idea of returns to scale. While economies of scale refer to a company's expenses, returns to scale represent the link across inputs and outputs in a long-run factor of output. A production function has constant returns to scale if raising all inputs by some percentage leads to output rising by that equal ratio. Returns drop if, for instance, multiplying inputs results in less than twice the output, and rise if more than double the outcome. If a mathematical function is employed to describe the production function, and if that production function is homogeneous, returns to scale are expressed by the level of homogeneity of the function.

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