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Internal Economies of Scale

The document discusses internal and external economies and diseconomies of scale. It provides examples of internal economies of scale including technical, managerial, financial, labor, risk-bearing, research, marketing, and commercial economies that can lower average costs as a firm increases production. External diseconomies of scale include market and environmental diseconomies that can increase average costs such as higher input prices, pollution, and congestion issues caused by many firms operating in one area.

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Nikhil Kasat
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1K views

Internal Economies of Scale

The document discusses internal and external economies and diseconomies of scale. It provides examples of internal economies of scale including technical, managerial, financial, labor, risk-bearing, research, marketing, and commercial economies that can lower average costs as a firm increases production. External diseconomies of scale include market and environmental diseconomies that can increase average costs such as higher input prices, pollution, and congestion issues caused by many firms operating in one area.

Uploaded by

Nikhil Kasat
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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Internal Economies of Scale: It refers to the reduction in the individual firms average cost of production as output increases(scale of production

expands) Technical Economies of Scale Managerial Financial Labour Risk-bearing Research Marketing Commercial

Technical: When expansion in scale of operations result in technological advantages (better machinery, etc) Also , if, for example , the size of the plant doubles, it doesnt imply that the labour required or the cost of production also doubles. e.g. A Machine A that makes 10,000 chocolates a day will NOT cost 10 times as much as a machine B that makes 1,000 chocolates a day. Neither will A require 10 times the space or labour used by B. Therefore, production becomes more cost effective Managerial: It arises from specialization and mechanization of management of a firm when it expands its scale of production. e.g. In a small company, the manager is also the worker, the foreman, and the manager. He hence wastes his time on small jobs. However, if the firm expands, there is specialization of management, and so the manager can delegate these tasks to junior employees. Therefore the firm is able to have specialized managerial staff looking after each department. Financial If a firm increases its size of operations, larger financial resources are available to it at lower costs-big firm more credible, can receive loans more easily e.g. Reliance, Tata and Birla Grp Companies are prime customers for any bank in India and attract the least rates of interest. On the other hand, some small scale industry will have to pay a higher rate of interest to the bank, as it is not viewed as very credit worthy. Marketing Economy When a firm increases its scale of operations, it is able to employ mass marketing strategies, such as T.V. advertising

e.g. Mango Frooti, manufactured by Parle Agro Pvt. Ltd. It was because of the tagline itself (mango fruity fresh and juicy) that its popularity increased. As the output grew, the company invested more in its advertisement campaigns. Risk-bearing When a firm expands its scale of operations, it can afford to take risks and also eliminate them. It does this by diversifying output. Diversification basically impacts its strength and stability and makes it less vulnerable to changes in commercial forms. e.g. Hindustan Unilevers Ltd.some of its brands include Kwality Walls icecream, Lux soaps, Pepsodent and Close Up, Lipton Tea, Lakme beauty products, Sunsilk and Dove shampoos, Vim dishwash, surf, rin, Clinic plus shampoo, etc. So, if one part of the company has a loss, other parts of the company can support it. (company will have enough capital to overcome the loss) Labour As the scale of the firm increases, it leads to division of labour and their specialization. This makes an individual labourer excel at his/her job in terms of speed, skill, dexterity, as she does only a PART of the job instead of the whole production process. Therefore more output per unit of factor input(labour) e.g. Imagine a small scale firm A that produces ready made shirts. It does not have much labour, therefore each labourer is involved in the whole process of producing one shirtmeasurement of cloth, cutting, stitching, pressing. If the scale of operations of the firm expands, it can employ more labour. Therefore the labour gets specialized in one aspect of the whole production process. Research Large scale firms can afford to have R&D departments which aim at developing new products and new methods of production. e.g. Ranbaxy. First Research activity was carried out in 1973. When Ranbaxy drew out an ambitious global plan, it established its first R&D center in 1994. Now, it has a state of the art multi disciplinary center for research, and its R&D expdt. In 2008 was around Rs. 4325 million Commercial When a firm expands its scale of operations, it gets advantages in the purchase of raw materials and in the sale of goods. Large firms have bargaining advantages when they buy in bulk. They also secure freight concessions from railways and road transport; prompt delivery, carful attention from dealers. e.g. a company like Cadbury. It buys raw materials like cocoa, sugar, milk in bulk and hence receives discounts. E.g. when a company

purchases steel from SAIL, it receives discounts on bulk order, as well as doorstep deliver

External Diseconomies of Scale: When external factors outside the control of the company increases its average costs, while the output increases, it is known as external diseconomies of scale. Market Diseconomies: When an industry expands, there is more competition between the firms for limited factors of production and raw materials. Therefore prices go up. Leads to higher wage rates, higher rents, higher rates of interest for procuring bank loans. Thus cost of production increases. e.g. If a group of textile industries are concentrated in a place producing , say, cotton, if there is overcrowding of industries, then the resources will start to deplete. And As labour is limited, wage rates will increase. Enivornmental Diseconomies: Firms incur pricate costs in producing chemicals, but dont pay for any of the social costs e.g. an upstream pulp mill discharges effluents in the river. This reduces the scope for fishing and hence poses an externality to the fishing industry. A steel factory produces a lot of smoke which causes health problems to the people living in neighbouring areas Nuclear Plants generate a radioactive atmosphere. Many industries located along the banks of the Penna River in Anantpur, Bihar Dump effluents like Calcium carbonate, lead and other substances that contaminate the water body. If there is overcrowding of firms in a particular area, it can cause road congestion, which can slow up deliveries and will lead to an increase in transport costs.

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