Question

What do you understand by External Economies of Scale? How do they become Diseconomies?

Answer 1

External Economies of Scale -

External economies of scale are those benefits and advantages which accrue to all the firms in an industry or market when the size of the industry or market expands. The may be of following types.

 

(a) Economies of Concentration :

When several firms from the same industry are concentrated at any one place then all of them are benefitted by this concentration. For example, skilled labour and raw material for that industry becomes easily available, finance, banking, insurance and other auxillary services become easily available at a low cost. If, however, somebody tries to set up this industry at a different place then several inconveniences arise and that increases the cost. In this way, this concentratio benefits all the firms set up at that place. 

 

(b) Economies of Information :

In a well developed industry information dissemination is done very easily. Many new magazines, journals and newspapers and T. V. programmes relating to that industry automatically come up and help any firm to know more about all aspects of that industry. Any development, technological or otherwise, in any part of the world becomes easily accessible over the entire world and this benefits all firms of that industry.

 

(c) Economies of Research & Development :

A developed industry can spend a lot of money for research and development, which helps improve productivity and lower costs. A well developed large industry can set up its own research institutes or finance research projects for its own purpose at other prestigious institutes. All these things benefit all units of that industry. In a less developed and small industry it is not possible.

 

(d) Economies of Negotiation :

A large industry has big impact and it has a big bargaining power in negotiation with government or other industries. They can even influence government policies in their favour. A small industry's impact is little and it can not easily influence the government. Thus, a large industry has the advantage of a strong negotiating power.

 

Diseconomies of Scale -

When the size of a firm or industry expands then it would get the advantage of the both internal and external economies respectively. But this is not unlimited, because after a point economies tend to become diseconomies. This applies on both internal and external economies. For example, if the size of a firm expands tremendously the labour costs increase because then the labour organise themselves into a strong trade union and press for higher wages. Another disadvantage is that due to increase in size, management and coordination becomes more difficult and this adds to additional overheads. Similarly, governmental regulations also become tighter.

     Similarly when the size of an industry grows, some economies tend to become diseconomies. For example, concentration of an industry at a particular place becomes a problem because trade unions become very strong and any dispute or problem at any one unit affects the entire industry. Similarly, a well developed industry appears to be a good source of revenue and the government tends to tax this industry heavily.

    In this way, we see that both internal and external economies tend to become diseconomies when both the size of the firm and industry grows beyond a point and this adds to cost of production. It is, therefore, essential for any firm to determine the right size for itself where it has the maximum of economies and minimum of diseconomies. However, it must be understood that the concept of right size is not a static one and is dependent upon particular circumstances of a firm and industry.

External economies of scale are those benefits and advantages which accrue to all the firms in an industry or market when the size of the industry or market expands. The may be of following types.