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Write explanatory notes on the various types of internal and external economies of scale.

Write explanatory notes on the various types of internal and external economies of scale.

Answers

Wilfred
1. INTERNAL ECONOMIES OF SCALE
Internal economies of scale are those obtained within the organization as a result of the growth irrespective
of what is happening outside. They take the following forms:
a. Technical Economies
i) Indivisibilities: These may occur when a large firm is able to take advantage of an industrial process
which cannot be reproduced on a small scale, for example a blast furnace which cannot be
reproduced on a small scale while retaining its efficiency.
ii). Increased Dimension: These occur when it is possible to increase the size of the firm?s
equipment and hence realize a higher volume of output without necessarily increasing the costs at
the same rate. For example, a matatu and a bus each require one driver and conductor. The output
from the bus is much higher than that from the matatu in any given period of time and although the
bus driver and conductor will earn more than their matatu counterparts, they will not earn by as
many times as the bus output exceeds the matatu output i.e. if the bus output is 3 times the matatu
output the bus driver and conductor will not earn 3 times the earnings of their matatu counterparts.
iii) Economies of Linked Processes: Technical economies are also sometimes gained by
linking processes together eg in the iron and steel industry where iron and steel production is carried
out in the same plant, thus saving on both transport and fuel costs.
iv) Specialization: Specialization of labor and machinery can lead to the production of better quality
output and higher volume of output.
v) Research: A large firm will be in a better financial position to devote funds to research
and improvement of its product than a small firm.
b) Marketing Economies
i) The buying advantage: A large-scale organization may buy its materials in bulk and therefore get
preferential treatment and buy at a discount more easily than a small firm.
ii) The packaging advantage: It is easier to pack in bulk than in small quantities and although for
a large firm the packaging costs will be higher than for small firms, they will be spread over a large
volume of output and the cost per unit will be lower.
iii) The selling advantage: A large-scale organization may be able to make fuller use of sales
and distribution facilities than a small-scale one. For example, a company with a large transport fleet
will probably be able to ensure that they transport mainly full loads, whereas a small
business may have to hire transport or dispatch part-loads.
c) Organizational:
As a firm becomes larger, the day-to –day organizations can be delegated to office staff, leaving managers
free to concentrate on the important tasks. When a firm is large enough to have a management staff they
will be able to specialize in different functions such as accounting, law and market research.
d) Financial Economies:
A large firm will have more assets than a small firm. Hence, it will find it cheaper and easier to
borrow money from financial institutions like commercial banks than a small firm.
e) Risk-bearing Economies
All firms run risks, but risks taken in large numbers become more predictable. In addition to this, if an
organization is so large as to be a monopoly, this considerably reduces its commercial risks.
f) Overhead Processes:
For some products, very large overhead costs or processes must be undertaken to develop a product, for
example an airliner. Clearly, these costs can only be justified if large numbers of units are subsequently
produced.
g) Diversification:
As the firm becomes very large it may be able to safeguard its position by diversifying its products,
processes, markets and the location of the production.

2. EXTERNAL ECONOMIES
These are advantages enjoyed by a large size firm when a number of organizations group together in an
area irrespective of what is happening within the firm. They include:
a) Economies of concentration: When a number of firms in the same industry band together in
an area they can derive a great deal of mutual advantage from one another. Advantages might include
a pool of skilled workers, a better infrastructure (such as transport, specialized warehousing, banking
etc) and the stimulation of improvements. The lack of such external economies is a serious handicap
to less developed countries.
b) Economies of information: Under this heading, we could consider the setting up of
specialist research facilities and the publication of specialist journals.
c) Economies of disintegration: This refers to the splitting off or subcontracting of
specialist processes. A simple example is to be seen in the high street of most towns where there are
specialist photocopying firms.
Wilfykil answered the question on February 6, 2019 at 08:55

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