The Concept of Economies

of scope and Economies of

scale.
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 The Concept of Economies of
scope :
If we produce different products in a single firm jointly, rather than production of the
goods in different firms separately and cost of production of joint product is less than
the cost of production of the goods produced separately, then it is called economics
of scope.
In the real world, we can see that, firms are producing more than one product in a
single firm rather than single product. For example, automobile companies produce
cars and trucks, computer firm produces desktops and laptops, universities produce
teaching and research, and poultry farm produces chicken and eggs.
Then, 'Economies of Scope'  are present, if it is cheaper to produce various products
jointly by a single firm than to produce the same product independently
by separate firm.
For example, economics of scope exists, if the total cost(TC) of jointly producing cars
(C)and trucks (T) is less than, if cars and trucks are produced independently by
different firms separately.
Symbolically, if TC (C,T) is less than TC(C) +TC(T)  economies of scope exist. 
 Causes Economies of Scope :
1. Facilities of common processing : The product may  use common processing
facilities. For example, different car models can be produced at the same plant.
2. Joint utilization of inputs : Sharing or joint utilization of inputs reduces unit cost. For
example, cars and trucks can be produced with the same metal sheet.
3. Use of by-products : When a firm produces a second product by utilizing by-
product, then per unit cost decreases. For example, sugar factory uses Molasses to
prepare power alcohol. 
4. Use of skill of employee : We can use of skill of employee to produce different
product. For example, employee of leather jacket can be used to prepare leather
purse and belt.
5. Sharing customers or distribution : We can share customers and distributor
for different products. For example, we can share same customers for Coke and
Pepsi.
6. Sharing assets and management : We can use same assets and management for
different products produced jointly. Like cars and trucks.
Derivation of Long run Marginal Cost Curve (LMC) :
• We can derive long run marginal cost curve (LMC) from long run average cost
curve (LAC). The process of derivation of LMC curve from LAC curve is given 
LMC
below. Y SAC 3
SMC1 SMC3
f LAC
SAC1 SMC2
a SAC2
c
Cost
b
e

O Q3 X
Q1 Q2
Output
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• In the figure, cost is measured along the vertical axis and output is measured
along the horizontal axis. LAC and LMC are long run average cost and long run
marginal cost curves. Similarly, SAC and SMC are short run average cost and short
run marginal cost curves.
• Now, if OQ1 output is produced in the long run, it is produced at point 'a' of LAC
where SAC1 is tangent, and its SMC is SMC1. Then, short run marginal cost of
output OQ1 = eQ1. 
• Similarly, if OQ2 output is produced in the long run, it is produced at point 'b' of
LAC, where SAC2 is tangent and its SMC is SMC2. Then, short run marginal cost of
output OQ2 = bQ2.
• Again, If we have to produce OQ3 level of output in the long run, it is produced at
point 'c', of LAC, where SAC3 is tangent and its SMC is SMC3. Then, short run
marginal cost of output OQ3 = fQ3. Now, joining these different points of short run
marginal cost curves of producing different level of output in the long run, like
e,b,f in the above figure, we can derive LMC curve in the long run. 
 The Concept of economies of Scale:
• The advantages or benefits received by a firm as a result of increase in its scale of
production are called 'Economies of scale'. Or it is a saving in per unit cost as
increase in scale of production. There are two types of economies of scale. They are
(A) Internal Economies, and (B) External Economies.
• (A) Internal Economies : Internal economies arise to the firm due to the expansion
of the plant size of the firm. These are internal in the sense that, these are received
by a particular firm, when its scale of production increases. These are
entirely depending upon the size of the firm and do not depend on other firms.
Therefore, due to the internal economies entire economy is not benefited, only
an individual firm receives benefits by increasing scale of production.
• The internal economies are-
1. Production Economies : Production economies arise from the use of factor of
production. They are -
I)  Labour economies : As the size of firm increases, the firm enjoys labour economies
due to the division of labour and specialization and per unit cost decreases.  
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II)  Technical economies : Technical economies arise from the use of better technique
of production or technological improvement. If a firm increases its scale of production ,
it can use specialized capital equipment, mechanization in production process, invest in
research and development etc. As a result, per unit cost of output decreases.
III)  Use of by-products : Large firm can use its waste materials to produce other goods.
For example, sugar factory can use Molasses to prepare alcohol. Similarly, furniture
factory can use small wood for making toys etc. By using by-products per unit cost of
output decreases.
IV)  Economy of bigger dimension : A large firm also enjoys economies in the use of
factor inputs. To double the output, it may not be necessary to double the plant, raw
materials, laboer and other inputs. We can use division of labour technique to improve
efficiency of labour and make more productive. We can use same plant more shifts etc.
V)  Inventory economies :We need some inventory to meet the random changes in
input and output sides of production. Inventories increase with the scale of production
but not proportionately.
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2. Managerial Economies : Large scale production makes possible for the division of
managerial function. Then firm can hire production manager, sales manager, finance
manager etc., and enjoys the benefit of division of labour in the management. The firm can
use qualified persons to look different department. This functional  specialization in
management increases the efficiency of the firm.
3. Marketing Economies : It is related to the purchase of raw material and sales of finished
products. Due to the regular and large quantity buying of raw material, a firm can get
concession in purchase. Similarly, sales promotion cost like, advertising cost, sample
distribution, salesmen force do not increase proportionately with the output. This is
marketing economies.
4. Financial Economies : A large firm can raise funds in large quantity in low interest
rate due to the reputation and adequate security to the bank. Large firm can also borrow 
funds by issuing bonds and shares to the public. The cost of capital of public borrowing will
be very low.
5. Transport and storage Economies : The unit cost of transportation of raw material and
finished product will fall because large firm can use large transportation vehicles and can get
concession in large scale transport. Also they have own vehicles for transportation. Similarly,
a large firm may have their own godowns and can save storage cost.
6. Research and Development : A large firm can take advantage of research and
development. A large firm has its own research and development wing, and it can
set up its own laboratories. It can employ  scientist and research worker for
innovating of new techniques. Then it uses new technique in production process
and reduces per unit cost of production.
7. Risk and survival Economies : A large firm can face the risk and uncertainties in
business than the small one. This is known as risk and uncertainties economies.
Internal Diseconomies:
Internal diseconomies are the disadvantages or disbenefits received by the firm
due to large scale production. Then per unit cost of output increases. They are-
I) Managerial diseconomies : The managerial capacity does not increase with the
scale of production overnight. Then manager must face excessive overburden.
Then he cannot take timely decision and emerges managerial inefficiency. Co-
ordination among different departments becomes difficult and arise problems in
business decision making. Then production cost increases.
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II)  Labour inefficiency : When scale of production expands, there will be

overcrowding of labour. There is loss of personal contact between owners and
workers and the firm must face labour trouble. Further, increase in number of
labours in the firm give rise to many trade unions. All these leads to fall in
efficiency and  increase cost of production.
III)  Technical Diseconomies : If production is carried out beyond the optimum
capacity of the plant, technological part does not work. Then technical
diseconomies arise in the business and per unit cost increases.
IV)  Market Constraint : Large firms are dependent on external market for
their sales. This makes them dependent on economic and political uncertainties
in other countries.
V)  Exhaustible Natural Resources : After some time, some natural resources
will exhaust. Then increasing scale of production will not increase output.
For example, increasing the fishing fleet may not increase in catching of the fish.
(B) External Economies : External economies are the  benefits received by the
whole industry, not by an individual firm, due to the increase in scale of
production. It is external in the sense that, these are received by the firm from
entirely outside than the individual firm. Suppose, if a firm invented a low-cost
production technique and it can be used by the whole industry and can be
benefited all firms. Similarly, if an industry is localized, government provides
various facilities like, communication, transportation, banking to the whole area
and all firms are benefited. This is external economies to the firm because these
facilities are externally supplied to the firm than from its own system. There are
various types of external economies. They are as follows :
i. Cheaper inputs : When  an industry expands, it demands large quantity of
factor inputs. Then input producing industries produce in large quantity and
supplies in low rate due to the large-scale production of  inputs.
ii. Technological economies : If an industry expands, it uses large funds for
research and development to find better technic of production and if new
technique is invented, all firms in an industry can be benefited.
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• III.  Supply of skilled labour : If an industry expands, the suppliers of skilled labour
industries are stablished there. Then they supply skilled labour at cheaper rate
constantly.
• IV.  Growth of subsidiary industries : When an industry expands, several
subsidiary industries will stablish there to provide goods and services to the
industry. They are hotels, restaurants, cinema halls, hospitals schools etc. They
provide service at cheaper rate.
• V.   Constant flow of information : When an industry expands, it
establishes publication and information desk. Then  there will be constant flow
of information about new market, new technic of production, new source of raw
materials etc.
• VI.  Economics of localization : When an industry expands, a wide verities
of facilities and services are provided by the government and receive benefits by
all firms. They are better transportation, communication, school, banking, day
care centers etc.
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• External Diseconomies
External diseconomies are the disbenefits received by all firms due to the increase
in the size of an industry. These are the detrimental / harmful effects of large-scale
production or externalities. They are -
i. Increase in input cost : When an industry expands, the demand for various
factor inputs increases. This will increase in input price and cost of production
increases.
ii. Higher wages : When an industry expands, the demand for skilled and unskilled
labour will increase and wage rate increases. Then cost of production also
increases.
iii. Costilier transportatoin : When an industry expands, excessive pressure goes
on transportation system and jams and accidents increase. Then it would be
difficult for transportation and per unit cost increases.
iv. Pollution increases.
v. Social crime increases.
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