Sunday, November 8, 2015

The reasons for economies and diseconomies of scale

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The economies of scale are the cost saving factors that arise due to the increase in the scale of production. It causes decrease in LAC. It is classified under:
A. Internal or Real economies
B. External economies
A. Internal economies:
i) Economies in production:
Production economies are of two kinds:
a. technical economies:
A large scale expanding firm can afford technically advanced plant and enjoy technical economies. Technical economies include the economies that arise due to the advantage of i) opportunity for using specialized machinery, ii) once-for-all cost of large scale set up and iii) scope of building reserve capacity etc.
b. Advantages of division of labor and specialization:
When firms scale of production expands, more and more qualified workers are employed. Then it becomes possible of division of labor. It increases efficiency and reduces cost of production.
ii) Economies in buying and selling:
A large firm can buy large scale of raw materials and enjoy discounts. So, cost of production reduces. With the increase of the firm, total production increases but the expenditure on advertising the product does not increase proportionately which reduces cost.
iii) Managerial economies:
In a large size firm, it becomes possible to divide the management into specialized departments. They have the opportunity to use advanced techniques of communication, telephones, computer etc. So, managerial cost increases less than proportionately with the increase in production scale.
iv) economies in transportation:
A large size firm may acquire their own means of transportation and can reduce the cost of transportation.

B. External economies:
Consider an example, growth fishing industry encourages growth of firms that supply fishing nets and boats. Competition among such firms (net, boat fishing firms) reduces cost of inputs (for fishing industry). So, cost of production decreases.

Reasons for increase in long run average cost (LAC) or diseconomies of scale:
Diseconomies of scale are disadvantages that arise due to the expansion of production scale and lead to rise in the cost of production. Like economies, diseconomies may be internal and external.
A. Internal diseconomies:
i) Managerial Inefficiency:
With fast expansion of the production scale, personal contacts and communication between a) owners and managers and b) managers and labor get rapidly reduced. this managerial inefficiency leads to rise in cost of production.
ii) Labor inefficiency:
Overcrowding of labor leads to loss of control on labor productivity. On the other hand, increase in the number of workers encourages labor union activities which means simply the loss of output and hence rise in cost of production.

B. External diseconomies:
When all the firm of the industry are expanding, it causes increasing demand of inputs and input price begin to rise causing a rise in cost of production. on the other hand, the law of diminishing returns to scale comes into force due to excessive use of fixed factors. For example, excessive use of cultivable land turns it into a barren land; pumping out water on a large scale for irrigation causes water level to go down resulting in rise in cost of irrigation. These kinds of diseconomies make the LAC more upward

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