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Theory of Production and Cost

External Economies and Diseconomies of Scale

External economies of scale happen externally i.e. not inside the organization but in within the industry. External economies reduce the average cost of the company. Since, cost per unit totally depends on the size of the industry, average cost decreases as industry size increases. The positive benefits to the firm are External economies of scale and negative externalities are known as External diseconomies of scale. A firm works on the principle of economies and diseconomies of scale. Economies and diseconomies of scale! Yes, in this section, we are going to know about more of economies and diseconomies of scale.

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External Economies and Diseconomies of scale

A firm in order to earn profit increases its size. Apart from this, there are many other changes which a firm adapt to make a profit. There are some economies and diseconomies of the scale associated with the firm.

An economy is the advantages that a firm earn due to some of its changes. The diseconomies are the disadvantage that a firm has to bear because of the same changes.

External economies and diseconomies of scale are the results of some external causes. These causes are not directly connected with the firms.

Learn more about Financial Economies of Scale here.

External Economies of Scale

As the name suggests, this scale occurs outside the firm but within the same industry. It is associated with an increase in the industry.

It benefits all the firms in the industry. Here, the cost depends on the size of the industry and not on the firm.

external economies of scale

Sources of External Economies

  • Economies of Concentration
  • Economies of Information
  • Economies of Specialization
  • Research and Development
  • Taxation

Economies of Concentration

It is the advantage of a firm due to its concentration.  Many other factors such as skilled labour, better transport facilities etc. also help in the economy of the organization.

Easy arrangement for repair, maintenance, communication, insurance, and special services is available to the firm.

Economies of Information

A firm needs continuous information from the industry like the cost of the inputs, products, policies, and other services are required by the organization.

When an industry provides the firms with this, it provides economies to the firm.

Economies of Specialization

The industry can have more than one firm in a particular area. These firms can help each other in their fields of specialization.

This not only provides support but also reduces the cost of their operation. The benefit is shared by all the firms.

Research and Development

The industry can have an R&D department. Running such a department reduces costs by developing more efficient methods and techniques.

Taxation

The cost falls when the Government reduces the tax on industries.

Learn about the Internal Economies here in detail.

External Diseconomies of Scale

The forces which ultimately limit the expansion of industry are the external diseconomies of the scale.  These are the result of external forces.

As the industry expands, this factor arises. The reason is the increase in factor price.

Sources of Diseconomies of Scale

  • Intense competition among the firms raises the cost of raw material.
  • The scarcity of electricity, water, finance, and other factors of production raises the price.
  • Local roads become congested and so the transportation cost begins to rise.
  • Local labour becomes scarce and firms have to offer higher wages to attract new workers.
  • Land and factories become scarce and rent begin to rise.
  • The localization of an industry in a specific region leads to pollution. This adversely affects their health. The social cost of production rises.

 

diseconomies of scale

Learn more about Business Economic here.

Solved Example for You

Problem: External economies accrue due to

  1. Increasing returns to scale
  2. Law of variable proportion
  3. Low cost

Solution: 1. Increasing returns to scale.

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