Economies and Diseconomies of Scale

Economies of Scale

When more units of a good or service can be produced on a larger scale, yet with (on
average) fewer input costs, economies of scale are said to be achieved. Economies of
scale are the cost advantages that enterprises obtain due to their scale of operation, and are
typically measured by the amount of output produced per unit of time. A decrease in cost per
unit of output enables an increase in scale.

Types of Economies of Scale

1. Internal Economies of Scale

This refers to economies that are unique to a firm. For instance, a firm may hold a patent
over a mass production machine, which allows it to lower its average cost of production
more than other firms in the industry. An internal economy of scale measures a company's
efficiency of production. That efficiency is attained as the company improves output when
the average cost per product drops. This type of economy of scale is a consequence of a
company's size and is controlled by its management teams such as workforce, production
measures, and machinery. The factors, therefore, are independent of the entire industry.

Technical Economies

Firstly, this can be achieved through improvements and optimizations within the production
process. When the output increases, the firm will invest more in efficient equipment and
optimise operation based on experience. Efficient machinery result in producing output at
lower cost.

Managerial Economies

The employment of specialised workforce result in managerial economies of scale. Hence as

the organisation grow, they hire more expert staff and create a specialised business unit. In
addition, the firm efficiency is increased by employing specialist, accountants, human
resource, etc which will result in reducing the cost of production and increase revenue.

Marketing Economies

Marketing economies of scale is the ability to spread advertising and marketing budget over
an increasing output. Thus as the production increases the firm can fix marketing expenses,
which will reduce the per unit cost of production. Thus, Better advertisement result in
reaching larger audience and increase the sale of the firm.

Financial Economies

Access of financial and capital market result in financial economies of scale. Hence large
firms find easier and cheaper to raise funds. As the firm grow, it is consider to be more
credit worthy. They can easily raise fund from banks, stock market
Commercial Economies of scale

Reduction in price due to discounts or bargaining power result in commercial economies of

scale. Larger firms can buy goods and services in larger quantities. Thus they get larger
discount and can bargain to negotiate lower prices. Moreover this means they pay less for
each item purchases.

Network Economies

When the marginal costs of adding additional customers are extremely low result in network
economies of scale. Hence this means larger firm can support large numbers of new
customers with their existing infrastructure can substantially increase profitability as they
grow.

2. External Economies of Scale

These refer to economies of scale enjoyed by an entire industry
(1) infrastructure, (2) specialization, (3) innovation, and (4) lobbying economies of scale.

Infrastructure Economies of Scale

Infrastructure economies of scale occur based on public infrastructure that is put in place to
benefit a specific industry. That means when many firms of the same industry are located in
close proximity, the government will usually expand public infrastructure (e.g., roads, public
transport) in those areas to meet their needs.

Specialization Economies of Scale

Specialization economies of scale arise when suppliers and workers start to focus on a
particular industry due to its size. That means as the companies within an industry increase
in size and numbers; it becomes more profitable for suppliers to focus exclusively on that
particular industry (by specializing and leveraging internal economies of scale). Similarly, it
becomes easier for specialized workers to find a job in their field because the availability of
jobs in the industry rises as well.

Innovation Economies of Scale

Innovation economies of scale occur based on increased public and private research. That
means as industries become increasingly significant, their impact on society grows into a
matter of public interest. That allows them to collaborate with universities and other research
facilities to improve their products and processes while simultaneously reducing their own
research expenses.

Lobbying Economies of Scale

Lobbying economies of scale arise from an increase in bargaining power as industries
become more significant. That means most governments will be ready to compromise
because they want to keep large industries in the area. The reason for this is that these
industries provide a lot of jobs and pay a significant amount of taxes. That gives them a lot
of bargaining power, which they’ll often use to negotiate favorable terms to cut costs or
increase profits.
Diseconomies of Scale

Diseconomies of scale occur when production scales up past the point of efficiency and unit
costs begin to rise instead of fall. In cases of diseconomies of scale, increases in production
output generate a negative effect since marginal costs also increase. This economic
phenomenon appears as an upward trend on the long-run average cost curve and results in a
decrease in profit and efficiency.

Types of Diseconomies of Scale

There are two main categories of diseconomies of scale: internal and external. While
internal diseconomies of scale result from factors within the company’s control, external
diseconomies of scale occur due to factors outside of a company’s influence. The different
types of internal and external diseconomies are:

1. Competitive diseconomies: A lack of a competitive market can create a diseconomy

of scale, as companies have no incentive to address inefficiencies and improve
processes. Ignoring process disorganization drives up the cost of production and
results in a competitive diseconomy of scale.
2. Infrastructure diseconomies: Business growth can also place constraints on local
infrastructure. The production process might develop problems if a company grows
to a point where natural geography cannot support it. For example, companies
constructing buildings in regions that cannot handle the manufacturing level might
experience an operational efficiency that results in a net loss.
3. Organizational diseconomies: Both small and large firms experience organizational
diseconomies of scale. When a business suddenly grows, the company needs to hire
new employees and open additional departments to scale effectively. Training new
employees drives up a company’s average costs. More departments also means more
potential for communication mishaps and management inefficiencies, which can also
create organizational diseconomies.
4. Purchasing diseconomies: Companies can also trigger poor spending habits as
businesses make more money. When a company experiences growth and an increase
in sales, owners are more willing to pay higher costs for the same resource inputs.
Known as a purchasing diseconomy, this spending phenomenon results in an increase
in total costs.
5. Technical diseconomies: This internal diseconomy occurs when companies grow at
a rate that is not scalable. As businesses grow, existing systems often require updates
to meet new demands; however, in the transitioning process, inefficiencies can create
additional costs, resulting in technical diseconomies of scale.

Causes of Diseconomies of Scale

Both internal and external factors result in diseconomies of scale. While causes vary
according to a company’s circumstances, below are common sources of diseconomies of
scale:

1. Organizational disruptions: In large companies, overseeing multiple departments

often results in organizational issues. Mismanagement and poor communication slow
down productivity and prevent optimal coordination. These types of organizational
disruptions are a common cause of the increased costs you can associate with
diseconomies of scale.
2. Rapid growth: When a company experiences sudden growth, the business becomes
less nimble and less able to integrate new technology and sales methods.
Diseconomies of scale often occur. As the demand for a product or service increases
to a point the business is not prepared to handle, production difficulties create a
diseconomy of scale. Such businesses might need to divest or downsize to reach
optimal cost savings.
3. Resource shortages: As the price of supplies increases due to limited availability or
high demand, overall production costs also increase. When resource shortages occur,
companies overpay for goods, reducing profitability and resulting in diseconomies of
scale.
4. Technical difficulties: Like organizational issues, technical disruptions can also
slow down a production line. Some common types of technical difficulties include
system overloads, process malfunctions, and security disturbances.