Economies of Scale
The term economies of scale refers to a situation where the cost of producing one unit of a good or service decreases as the volume of production increases.
Economies of scale arise when the cost per unit falls as output increases. Economies of scale are the main advantage of increasing the scale of production.
Alfred Marshall made a differentiating concepts of internal and external economies of scale. That is that when costs of input factors of production go down, it is a positive externality for all the firms in the market place, outside the control of any of the firms.
Internal Economies of Scale
Internal economies of scale relate to the lower unit costs a single firm can obtain by growing in size itself. This means that the internal economies are exclusively available to the expanding firm.
Internal economies of scale may be classified under the following categories.
- Bulk- buying economies: As businesses grow they need to order larger quantities of production inputs. For example, they will more raw materials. As the order value increases, a business obtains more bargaining power with suppliers. It may be able to obtain discounts and lower prices for the raw materials.
- Technical economies: Businesses with large-scale production can use more advanced machinery (or use existing machinery more efficiently). This may include using mass production techniques, which are a more efficient form of production. A larger firm can also afford to invest more in research and development.
- Financial economies: Many small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is often quite high. This is because small businesses are perceived as being riskier than larger businesses that have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at lower interest rates.
- Marketing economies: Economies in marketing arise from the large —scale purchase of raw materials and other material inputs and large scale selling of the firm’s own product. Every part of marketing has a cost — particularly promotional methods such as advertising and running a sales force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales — cutting the average marketing cost per unit.
- Managerial economies: As a firm grows, there is greater potential for managers to specialize in particular tasks (e.g. marketing, human resource management, finance). Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles.
External Economies of Scale
External economies of scale occur when a firm benefits from lower unit costs as a result of the whole industry growing in size. External economies accrue to the expanding firms from advantages arising outside the firm e.g. in the input markets.
The main types are:
- Transport and Communication: As an industry establishes itself and grows in a particular region, it is likely that the government will provide better transport and communication links to improve accessibility to the region. This will lower transport costs for firms in the area as journey times are reduced and also attract more potential customers.
- Training and education becomes more focused on the industry: Universities and colleges will offer more courses suitable for a career in the industry which has become dominant in a region or nationally. For example, there are many more IT courses at being offered at colleges as the whole IT industry in India has developed recently. This means firms can benefit from having a larger pool of appropriately skilled workers to recruit from.
- Other industries grow to support this industry: A network of suppliers or support industries may grow in size and/or locate close to the main industry. This means a firm has a greater chance of finding a high quality yet affordable supplier close to their site.
Economies of Scope
Economies of scope is a term that refers to the reduction of per-unit costs through the production of a wider variety of goods or services.
Many firms produce more than one product. Sometimes, a firm’s products are closely linked to one another. An automobile company, for instance, produces automobiles and trucks, a chicken farm produces poultry and eggs. At other times, firms produce physically unrelated products. In both cases, however, a firm is likely to enjoy production or cost advantages when it produces two or more products.
These advantages could result from the joint use of inputs or production facilities, joint marketing programs, or possibly the cost savings of a common administration.
For example, McDonalds can produce both hamburgers and French fries at a lower average cost than what it would cost two separate firms to produce the same goods. This is because McDonalds hamburgers and French fries share the use of food storage, preparation facilities, and so forth during production.
Difference between Economies of Scale and Economies of Scope
|Economies of scope||Economies of scale|