Economies of Scale
'Economies' mean advantages. Scale refers to the size of unit. 'Economies of Scale' refers to the cost advantages due to the largersize of production. As the volume of production increases, the overhead cost will come down. The bulk purchase of inputs will give a better bargaining power to the producer which will reduce the average variable cost too. All these advantages are due to the large scale production and these advantages are called economies of scale.
a) Internal economies of scale; b) External economies of scale
1. 'Internal economies of scale' are the advantages enjoyed within the production unit. These economies are enjoyed by a single firm independently of the action of the other firms. For instance, one firm may enjoy the advantage of good management; another may have the advantage of more up-to-date machinery. There are five kinds of internal economies. They are Technical Economies: As the size of the firm is large, the availability of capital is more. Due to this, a firm can introduce up-to-date technologies; thereby the increase in the productivity becomes possible. It is also possible to conduct research and development which will help to increase the quality of the product.
2. Financial Economies: It is possible for big firms to float shares in the market for capital formation. Small firms have to borrow capital whereas large firms can buy capital.
3. Managerial Economies: Division of labour is the result of large scale production. Right person can be employed in the right department only if there is division of labour. This will help a manager to fix responsibility to each department and thereby the productivity can be increased and the total production can be maximised.
4. Labour Economies: Large Scale production paves the way for division of labour. This is also known as specialisation of labour. The specialisation will increase the quality and ability of the labour. As a result, the productivity of the firm increases.
5. Marketing Economies: In production, the first buyer is the producer who buys the raw materials. As the size is large, the quantity bought is larger. This gives the producer a better bargaining power. Also he can enjoy credit facilities. All these are possible because of large scale production. Buying is the first function in marketing.
6. Economies of survival: A large firm can have many products. Even if one product fails in the market, the loss incurred in that product can be managed by the profit earned from the other products.
When many firms expand in a particular area - i.e., when the industry grows - they enjoy a number of advantages which are known as external economies of scale. This is not the advantage enjoyed by a single firm but by all the firms in the industry due to the structural growth. They are
1. Increased transport facilities
2. Banking facilities
3. Development of townships
4. Information and communication development
All these facilities are available to all firms in an industrial region.
The diseconomies are the disadvantages arising to a firm or a group of firms due to large scale production.
Internal Diseconomies of Scale
If a firm continues to grow and expand beyond the optimum capacity, the economies of scale disappear and diseconomies will start operating. For instance, if the size of a firm increases, after a point the difficulty of management arises to that particular firm which will increase the average cost of production of that firm. This is known as internal diseconomies of scale.
External Diseconomies of Scale
Beyond a certain stage, too much concentration and localisation of industries will create diseconomies in production which will be common for all firms in a locality. For instance, the expansion of an industry in a particular area leads to high rents and high costs. These are the external diseconomies as this affects all the firms in the industry located in that particular region.
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