BBA I Semester Managerial Economics Dis economies Scale Study Material Notes
Table of Contents
BBA I Semester Managerial Economics Dis economies Scale Study Material Notes: Economies of Scale IntrnalEconomies External Economies Diseconomies of Scale Internal Diseconomies ExteranL Dieconmies Exercises ( This Is Most Important Topic For BBA I Semester Students )
MCom I Semester Business Environment Meaning Features Classification Study Material Notes
ECONOMIES AND DISECONOMIES OF SCALE
ECONOMIES OF SCALE
An economy of scale exists when larger output is associated with lower per units cost. Economies of scale have been classified by Marshall into Internal Economies and External Economies.
Internal Economies
Internal Economies are internal to a firm when it expands its size or increases its output. They are open to a single factory or a single firm independently of the action of other firms. They result from an increase in the scale of output of the firm, and cannot be achieved unless output increases.
Internal economies are “associated with a reduction in the physical quantity of inputs, raw materials, various types of labour and various types of capital (fixed or circulating) used by a large firm.” Real internal economies which arise from the expansion of a firm are the following:
1 Labour Economies. As the firm expands, it achieves labour economies with increased division of labour and specialisation. When a firm expands in size, this necessitates division of labour whereby each worker is assigned one particular job. This, in turn, leads to the increase in the skill of every worker, the saving in time to produce goods, and to the efficiency of labour.
2. Technical Economies. Technical economies are associated with all types of machines and equipments used by a large firm. They arise from the use of better machines and techniques of production which increase output and reduce per unit cost of production.
3. Economies of Indivisibility. Some factor are indivisibility. Fixed capital is indivisible in the sense that a machine, an equipment or a plant must be used in a fixed minimum size. Such machines can be most efficiently used for a large output than for small outputs. For example, if in a car assembly plant the number of cars to be assembled is small, much of the plant would remain idle. But a large firm assembling a large number of cars is able to utilise the plant to its full capacity and lower the cost of cars.
4. Economies of Increased Dimensions. The cost of operating large machines is less than that of operating small machines. Even the cost of construction is relatively lower for large machines than for small ones. For example, the cost of manufacture of a double-decker bus is lower than the manufacture of two single-decker buses. Moreover, a double-decker carries more passengers than a single-decker and requires only a driver and a conductor. Thus its operating costs are relatively lower.
5. Marketing Economies. A large firm reaps the economies of buying and selling. It buys its requirements of various inputs in bulk at favourable terms of better quality, prompt delivery, transport concessions, etc. It produces quality products which it sells through expert salesmen, propaganda and advertisements. Thus a large firm by economies of marketing is able to reduce costs and earn more profit.
6. Managerial Economies. A large firm can employ specialists to supervise and manage the various departments, such as for manufacturing, assembling, packing, marketing, administration, etc. This leads to specialisation which increases the productive efficiency of the firm. These managerial economies also reduce cost of production.
7. Risk-Bearing Economies. A large firm can take risks and bear uncertainties. It can produce a variety of products, and sell them in different areas. By the diversification of its products, the large firm is able to reduce risks by the loss of one product with the gain from other products. It can avoid risks by having alternative sources of supply in the case of power by installing a generator of its own.
8. Economies of Research. A large firm possesses larger resources. It can establish its own research laboratory and employ trained research workers. When they invent new production techniques or processes, it utilises them for increasing its output and reducing costs.
9. Economies of Welfare. All firms have to provide welfare facilities to their workers. But a large firm can provide better working conditions in and outside the factory. It run subsidised canteens, provide creches for the infants of women workers, and recreation rooms for the workers. It may also provide cheap houses, educational and medical facilities for the families of workers.
10. Pecuniary or Monetary Internal Economies. Pecuniary or monetary internal economies accrue to a large firm solely through reductions in the market prices of its inputs. They arise when (1) it purchases raw materials in bulk at lower prices from its suppliers; (ii) it gets loans from banks and other financial institutions at low-interest rates; (iii) it raises capital by floating shares at a premium and debentures at low-interest rates in the capital market; (iv) it advertises at concessional rates on a large scale in different media; (v) it transports large quantities of its commodity at concessional transport rates. Thus pecuniary economies are “realised from paying lower prices for the factors used in the production and distribution of the product, due to bulk-buying by the firm as its size increases”.
Dis economies Scale
External Economies
External Economies are external to a firm which are available to it when the output of the whole industry expands. They are shared by a number of firms or industries when the scale of production in any industry or group of industries increases. External economies accrue to firms when the industry is localised in a particular area, makes inventions and specialises in different processes.
These external economies are discussed below.
1 Technical Economies. Technical external economies arise from specialisation. When an industry expands in size, firms start specialising in different processes and the industry benefits on the whole. For example, in the cotton textile industry some firms may specialise in manufacturing thread, others in printing, still others in dyeing, some in long cloth, some in dhotis, some in shirting, etc. As a result, the productive efficiency of the firms specialising in different fields increases and the unit cost of production falls.
Further, subsidiary industries develop to supply the localised industry with tools, equipment and raw materials, and special services for repairs and maintenance of plants and equipments, thereby lowering the unit cost of production of all the firms.
2. Economies of Information. As an industry expands, it specialises in collecting and spreading market information to the firms. It can set up research laboratories and employ experienced research personnel and publish a scientific journal. The industry can also set up an information centre which passes on information regarding the availability of raw materials, modern machines, export possibilities etc. to the firms. All this helps in raising the productive efficiency of the firms and reduction in their costs.
3. Economies of By-products. When an industry is localised, it turns out large quantities of waste materials, such as molasses in sugar industry and iron scrap in steel industry. New firms enter the industry which purchase these waste materials at reasonable prices and use them for manufacturing by-products. The firms in the industry are able to reduce per unit cost in two ways: first, they do not incur expenses in disposing of the waste materials, and second, they earn some amount by selling them to manufacturers of byproducts.
4. Pecuniary or Monetary External Economies. Pecuniary or monetary external economies arise to firms in an industry from reductions in factor prices. Such reductions in factor prices may arise from a number of sources: (1) Local educational institutions specialise in the type of courses needed by the industry, thereby making available skilled labour to all the firms. (2) Supplementary industries are developed in the area. (3) Skilled workers and managers migrate to the area to meet the needs of the local labour market. (4) Transport and communications infrastructure are developed to meet the special needs of the industry. As a result the cost of transportation decreases. (5) The electricity company supplies adequate and continuous power to the firms at concessional rates. (6) Banks, insurance companies and other financial institutions open their offices in the area and provide cheap and timely credit and insurance facilities.
Dis economies Scale
DISECONOMIES OF SCALE
A diseconomy of scale exists when larger output leads to higher per unit cost. The economies of scale cannot continue indefinitely. A time comes in the life of a firm or an industry when further expansion leads to diseconomies when large output leads to higher cost of production Internal Diseconomies
When a firm expands beyond an optimum level, a number of problems arise such as factor shortages, lack of coordination and management, marketing and technological difficulties, etc. They tend to raise per unit cost of production. Internal diseconomies arise from the following:
(1) Managerial Diseconomies. When a firm expands beyond a limit, it becomes difficult to supervise and control the business properly. Supervision becomes lax. Workers do not work efficiently, wastages arise, decision-making becomes difficult, coordination between workers and management disappears and per unit cost increases.
(2) Marketing Diseconomies. The expansion of a firm beyond a certain limit leads to marketing problems. Raw materials may not be available due to scarcities. The demand for the products of the firm may fall as a result of changes in tastes of the people and the firm may not be in a position to change accordingly in the short period. The market organisation may fail to foresee changes in market conditions whereby the sales might fall.
(3) Technical Diseconomies. As the firm expands beyond the optimum level, there are repeated breakdowns in plants and equipments and the firm fails to operate its plant to its maximum capacity. It may have excess capacity or idle capacity. As a result, per unit cost increases.
(4) Diseconomies of Risk Taking. As a firm expands, risks also increase with it. An error of judgement on the part of the sales manager or the production manager may adversely affect sales or production which may lead to a great loss.
(5) Pecuniary or Monetary Internal Diseconomies. Pecuniary or monetary internal diseconomies arise when the prices of factors used in the production and distribution of the commodity increase. As a firm expands, labour may be available at higher wages, raw materials at higher prices, and finance at a high interest rate. Marketing, sales and transport expenses increase with the expansion of the firm. All these factors raise per unit cost.
External Diseconomies
External diseconomies arise when an industry expands as a whole, its growing demand for the various factors of production, like labour, capital, raw materials, etc. may eventually raise their prices. The localisation of industries may lead to shortages of transport, power, labour, raw materials and equipments. All such external diseconomies tend to raise cost of production.
As an industry expands, pecuniary external diseconomies arise when the prices of factors increase. The demand for factors like labour, capital equipment, raw materials, etc. increases on the part of firms which raise their prices. The expansion of an industry leads to shortages of labour, capital equipments, raw materials, power, transport, etc. which further raise their prices and lead to the rise in per unit costs of firms.
EXERCISES
1 What are internal economies of scale? How they arise in the case of a firm?
2 what are external diseconomies of scale? When they occur in a firm?
3. Explain internal diseconomies of scale.
4. Explain external economies of scale.
