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Economies & Diseconomies of Scale – Internal & External

As a firm expands its scale of production, its average cost may fall or rise due to economies and diseconomies of scale.

1. Economies of Scale – Meaning

Economies of scale are the cost advantages that a firm enjoys due to expansion in the scale of production, leading to fall in average cost.

Types:

  • Internal economies – enjoyed by individual firm.
  • External economies – enjoyed by all firms in an industry.

2. Internal Economies (Firm-Specific)

(a) Technical Economies

  • Large machines more efficient.
  • Better utilisation of by-products.

(b) Managerial Economies

  • Specialised managers for production, finance, marketing.

(c) Marketing Economies

  • Bulk buying of raw materials at discount.
  • Large-scale advertising spread over more units.

(d) Financial Economies

  • Big firms get loans at lower interest rates.

(e) Risk-Bearing Economies

  • Diversification of products & markets reduces risk.

(f) Research & Development Economies

  • Large firms can spend more on R&D → better technology.

3. External Economies (Industry-Wide)

  • Development of skilled labour in region.
  • Better transport and communication facilities.
  • Growth of ancillary industries (spare parts, services).
  • Government support, industrial clusters.
Exam Tip
In answers, clearly separate internal and external economies with headings and examples.

4. Diseconomies of Scale

Diseconomies of scale are disadvantages that arise when firm becomes too large, causing average cost to rise.

(a) Internal Diseconomies

  • Managerial inefficiency – difficult to control very large organisation.
  • Coordination problems – slow decision-making.
  • Labour issues – trade union conflicts, low morale.

(b) External Diseconomies

  • Overcrowding of industry in one region → high land & wage costs.
  • Pollution and congestion.
  • Government restrictions due to environmental concerns.

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5. Relation with Long-Run Average Cost (LAC)

  • Due to economies of scale, LAC falls initially.
  • After a certain optimum scale, diseconomies of scale may dominate → LAC rises.
  • Gives U-shaped long-run average cost curve.

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6. Quick Revision Points

  • Economies of scale → falling average cost with expansion.
  • Diseconomies of scale → rising average cost beyond optimum size.
  • Internal vs external economies/diseconomies important for exam answers.

7. Quiz Time 🎯

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