ECONOMIES OF SCALE AND DISECONOMIES OF SCALE Unit Structure : 6.0 Objectives 6.1 Introduction 62 Economies of scale 6.3 _ Internal economies of scale 6.4 _ Internal diseconomies of scale 6.5 _ External economies of scale 6.6 _ External diseconomies of scale 67 Economies of scope 68 Summary 69 Questions 6.0 OBJECTIVES * To study the internal and external economies and diseconomies of scale * To understand the economies of scope 6.1 INTRODUCTION ‘Adam smith in his famous book ‘Wealth of the Nation’ 1776 analyse the advantages of Division of labour which is capable of generating economies of scale in static as well as in dynamic sense. Economies of scale is a real phenosmenon to the real-world situation which helps to understand the real situation in the world economy. In microeconomics, economies of scale is a cost advantage method of production where the firm operates its level of output by producing the scale of operation with cost per unit of output decreases with the increasing scale of output. Where the diseconomies of scale are the opposite of economies of scale. 6.2 ECONOMIES OF SCALE According to Alfred Marshall Economies of scale are broadly classified into Internal economies of scale and external economies of scale. In the large-scale production, the cost of production should be low which is called as economies of scale. A firm enjoy internal economies of scale when he expands his size or scale of78 production in economy by making changes in the internal factors of production. Where on the other hand a firm enjoy intemal economies of scale when he expands his size of production in ‘economy by making changes in the external factors of production. So now we will explain both intemal and external economies of scale in details. INTERNAL ECONOMIES OF SCALE Internal economies of scale are an increase in the scale or size of production or output of a firm these are solely enjoyable by firm independently by making changes in the input factors of production into his business. The internal economies of scale have various different types which are as follows: 1) Labour economies: Adam smith in this book “An inquiry into the nature and causes of the wealth of the nation” 1776 emphasised on the division of labour. Economies of labour also implies the benefit which is arising in the scale of economy due to division of labour. Division of labour increases the efficiency in production which leads to increase in the size of output. Division of labour bring specialisation in labour skills and also saves time which in tum increases the level or scale of output. Thus, with the specialisation of division of labour the firm produces large scale of production. 2) Technical economies: technique of production also increases the scale of production. In other words, technical economies refer to increase in the scale of production due to change in technical or methods of production which reduces the cost of production. Technical economies increase the dimension of firms where the average cost of production decreases and average revenue will be high. 3) Managerial economies: Manager plays an important role in managing business activities. Managerial economies refer to the specialisation of managerial function which increases the level of output. It is a mangers duty to carry out all the managerial decision efficiently and effectively in the business organisation. Division of managerial activities increases the management of the business efficiently. 4) Financial economies: finance plays and important role in process of production. It is one of the important and essential factors of production. It is always observed that the large firms enjoy the benefit of better credit facility from banks then the small- scale firm. They also get the credit quickly and easily then the small firm or producer79 5) Marketing economies: marketing economies deals with the process of buying raw materials and selling of finished goods. A large firm have a great bargaining power. By using firm raw material at cheaper cost because it buys in bulk then the small firm. This in tum helps him to produce more at less cost and sell large amount of output in the market than the small firm. 6) Transport and storage: The large-scale firm have its own transport and storage facility which reduces his transportation and storage cost. This reduces the average cost of large-scale firm and increase the scale of output or revenue. Where the small-scale firms hire or pay rent for the use of transport and storage facility. 6.4 INTERNAL DISECONOMIES OF SCALE If the firm is unable to manage the level of output or the scale of operation diseconomies of scale occurs. If firm do not understand the importance of the specialisation of division of labour and specialisation of division management activities the level of output or scale of operation decreases leads to diseconomies of scale in economy. Suppose a firm take huge amount of loan from a financial institution or banks to expand his level of output. Such loan increases the burden on firm to prove their credit leads to financial diseconomies of scale. Check your Progress : 1) What are Internal Economies of Scale? 2) What are Internal Diseconomies of Scale? 6.5 EXTERNAL ECONOMIES OF SCALE External economies of scale refer to those economies which provides benefits and facilities to all firms of given industry. It is an economy which is enjoyed by all firms of industry irrespective of their size of operation. External economies of scale are also of various types which are follows: 1) Localisation economies: when a number of firms are located on one place with an objective of deriving the mutual benefits of training of skilled labour, provision of better transport facility etc. all these advantage helps the firm to reduce cost of production. Thus,80 localisation economies refer to concentration of a particular industry in one area which results in the development of conditions of industry which will reap the mutual benefits of all firms in the economy. 2) Disintegration economies: disintegration means firms splitting up its operation and the process of manufacture and handing over the specialised agency and institution is called economies of disintegration. There are two types of disintegration such as vertical and horizontal disintegration of economies. The firm which operates on disintegration of economies of scale will be able to get ‘economies of scale when it operates on a large scale. 3) Information economies: proper information in economy plays an important role for the producer to grow his economy. Networking with each other enables firms to make marketing and technical information easily. 4) By-product economies: to manufacture by-products a large- scale firm make use of waste material. This will help all the firm in the industry to reduce the waste in the economy and make efficient use of resources. This will ultimately reduce the cost of production and increase the level of output 6.6 EXTERNAL DISECONOMIES OF SCALE External diseconomies of scale results when there is an increasing in the total cost of production beyond the control of a company and it reduces the level of output. The increase in costs can be due to increase in the market price of factors of production. The external diseconomies are not suffered by a single firm but by whole firms operating in a given industry. These diseconomies arise due to much concentration and localization of industries beyond a certain stage. For example, Localization may lead to increase in the demand for transport and, therefore, transport costs rise and it leads to diseconomies of scale in the economy. 6.7 ECONOMIES OF SCOPE Economies of scope refer to a situation where in the long-run a firm tries to reduces average and marginal cost of production by producing large varieties of output. In other words, economies of means a firm produces multiple products instead of producing one single product to increases his scope of output by using the same equipment’s and machine as a result of this average cost decreases.81 Economies of scope is different from economies of scale, in that where the former means producing a variety of different products or multiple of product together to reduce costs while the latter means producing more of the same product in order to reduce the costs by increasing the efficiency in production. Economies of scope can arise from the co-production relationships between the final products or the actual products. In economic terms these goods are complements in production. This is when the production of one good automatically produces another good as a by-product or a kind of side-effect in the production process. Sometimes one product might be a by-product of another, but have value for use by the producer or for sale. Finding a productive use or market for the co-products can reduce costs or increase revenue. For example, dairy farmers separate milk into whey and curds, with the curds going on to become cheese. In the process they also end up with a lot of whey, which they can use as a high protein feed for livestock to reduce their feed costs or sell as a Nutritional product to fitness enthusiasts and weightlifters for additional revenue. Another example of this is the black liquor produced by the processing of wood into paper pulp. Instead of being just a waste product that might be costly to dispose of, black liquor is burned as an energy source to fuel and heat the plant, saving money on other fuels, or can even be processed into more advanced bio-fuels for use on-site or for sale. Producing and using the black liquor saves costs on producing the paper. Check your Progress : 1) What do you mean by Economies of scope? 2) What is by product economies? SUMMARY The current unit studied the concept of economies and diseconomies of scale in detail. According to Alfred Marshall Economies of scale are broadly classified into Internal economies of scale and external economies of scale. In the large-scale production, the cost of production should be low which is called as82 economies of scale. Internal economies of scale are an increase in the scale or size of production or output of a firm these are solely enjoyable by firm independently by making changes in the input factors of production into his business. External economies of scale refer to those economies which provides benefits and facilities to all firms of given industry. It is an economy which is enjoyed by all firms of industry irrespective of their size of operation. It also discuss the internal factors and external factors of scale in details. 6.9 QUESTIONS 1) Explain the internal and external economies of scale. 2) Explain in brief external economies and diseconomies of scale. 3) Write a short note on: Economies of scope SESS