In: Economics

# Returns to Scale in Economy.

What do you understand by Returns to Scale in Economics?

What do you unserstand by Economies of Large Scale Production? What are the categories of Economies of Large Scale Production?

Define Internal Economies of Scale.

## Solutions

##### Expert Solution

RETURNS TO SCALE -

We would analyse the behaviour of production when all factors are simultaneously increased in a given ratio. This is called 'Returns to Scale'.

If we increase all our factors of production by, say, 20 percent, then total output may rise in any one of the following conditions.

(i)     > 20%

(ii)    = 20%

(iii)   < 20%

The first type of increase will be called Increasing Returns Scale. If increase in output is in the same proportion as mcrease in factors, then it is called Constant Returns to Scale and if increase in output is proportionately less than the increase in factors it is called Decreasing Returns to Scale.

When, the scale of production is continuously increased, then first we get increasing returns to scale, then constant returns to scale and finally we get decreasing returns to scale.

Economies of Large Scale Production

Where all factors of production are increased, the scale of production changes. When we work at a large scale, then many benefits and economies are received by the producer. They can be divided into two categories.

(a)  Internal Economies of Scale

(b)  External Economies of Scale.

Internal Economies of Scale -

Internal economies are those benefits and economies which accrue to a firm when its size expands. They can be further subdivided into following sub-groups:

(a)  Labour Economies :

When the size of a firm expands, it makes a lot of saving in its labour cost. The main reason for this saving is specialization and division of labour. When a work is done at a small scale, then the labour has to do a variety of jobs. If the work is done at a large scale, then the work is divided into several processes. As a result, each labour has a specific job process and he develops specialization in that job. This increases efficiency and productivity and, therefore the labour cost goes down.

(b) Purchase Economies :

Every firm is required to purchase a lot of raw material and many other items to meet its production needs. When a firm works at a large scale the suppliers of raw material give them discounts and supply goods on credit. This reduces cost. Small firms, on other hand, purchase their goods on small scale and hence they have to pay a higher price.

(c) Marketing Economies :

A small firm has to face many problems in selling their products and they have to incur high cost of marketing. Big firms, on the other hand have several advantages in marketing their products. They can create their own dealer network, can enter into distant markets and can use electronic media for effective advertising. Because of these things, the marketability of their products increases, at a relatively lower cost.

(d) Financial Economies :

In the matter of finance also, large firms are in a position of advantage. Small firms often have to go to money lenders or indigenous bankers to meet their credit needs, where the rates of interest are high. As against this, a large firm or a company can fulfill their credit needs from the organised markets, where interest rates are low. They can even raise funds from international markets, where low cost finance is available. The important fact is that as compared to a small firm, the large companies have a far better reputation or goodwill, and hence they have an advantage both in the matters of cost and availability of finance.

(e) Technological Economies :

Large firms are in advantageous position in the matter of new methods and techniques of production because new and advance technology development is mostly targeted for large scale production and are not suitable for small scale operations. Thus, when we work on a small scale, the costs go up, as compared to large scale production.

(f) Managerial Economies :

Large scale operation provides many managerial advantages, like specialisation, skilled management staff, training of employee, organisational development etc. For a small scale producer these thing are not possible because they have meagre resources and few employees. Hence, it is not possible for them to apply advanced management techniques.

We would analyse the behaviour of production when all factors are simultaneously increased in a given ratio. This is called 'Returns to Scale'.

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