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 which 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 on 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 and 2) External Economies.

  1. Internal Economies: Internal Economies are the real economies which arise from the expansion of the organisation. These economies are the result of the growth of the organisation itself.

  2. 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 which 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 which 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

Q. 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 which affect the cost of production per unit. The External Economies of Scale are the factors which 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

  1. 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.

  2. 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. 

  3. Managerial Economies of Scale: This occurs when large organisations employ people with a special skill set which helps to maximize the profits of the organisation like an accountant or manager.

  4. Marketing Economies of Scale: This occurs when large organisations increase their budget. They can then spread their market by setting up branches or buy more raw materials in bulks with lesser price.

FAQs (Frequently Asked Questions)

1. What is a Bottleneck?

Answer: A bottleneck is a congestion point in an organisation 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 which have just started the production of something new are at a greater risk of a bottleneck since they do not have enough skilled labourers. 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 labourers.

2. What are the Causes of Diseconomies of Scale?

Answer: 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 Diseconomy of Scale. Due to lack of communication, there is no feedback given to the employees which are critical to their efficiency.

  • Poor Management Skills: In a gigantic organisation, it becomes difficult to manage all the sectors of the organisation. It is harder to make all the employees work towards the same goal in large organisations.

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