Economies of scale is one of the most important concepts of macro economics which emphasizes on the cost advantage a firm can obtain in long run. It’s not only a sole concept rather it has a connotation in the real life as well.
Economies of Scale Defined
An economy of scale is basically increasing the efficiency of the production process as the number of goods being produced increases. As a result of which, the more number of units one produces the average cost per unit decreases.
Let’s see in number how it happens –
Now if we notice closely even if the total cost has increase in accordance with the increase in outputs, the average cost per unit decreases gradually.
Economies of Scale: Graphical Representation
The following graph will show you how it happens –
Figure – 1
Figure – 2
From this two figures it’s clearly visible the effect of economies of scale on total cost and average cost. In figure one the total cost increases as the output increases and at the same time in the second figure the movement of the graph is inverse i.e. as the output increases the average cost per unit decreases.
Economies of Scale: Classification
There are two kinds of economies of scale. It doesn’t distinguish themselves in the way of occurrence rather it’s different under the scope of cost reduction. First one is internal economies of scale in which company decreases its cost by producing more. We can call internal economies of scale as micro economies of scale.
On the other hand there is another economy of scale which is called external economies of scale includes the whole industry. Due to better channel system if the firm within an industry reduces its cost then it’s said that external economies of scale has been achieved. We can call external economies of scale as macro economies of scale. The benefit of these macro economies of scale includes all firms within the industry.
Opposite of Economies of Scale: Diseconomies of Scale
Like economies of scale due to certain reasons diseconomies of scale also may happen. We can consider following reasons for diseconomies of scale –
- Inefficient Production Process
- Unproductive labors
- Ineffective management
- Increase in labor turnover ratio
- Inefficient industry norms
- Barriers of policies and legalities
A diseconomy of scale is basically increasing of average cost per unit in accordance with the increase of the output in a large firm.
If the above factors are taken care of, then the large firm can avoid diseconomies of scale in effective manner.
There is lots of debate going on that whether economies of scale is good or not! You could ask me why? The reason is to achieve economies of scale a firm needs to be really big and produce a lot more than a small cap company is presently doing. And thus in trying to become cost effective the companies are losing personal connection with the customers and employees. Though, achieving economies of scale, internal and external are not at all bad however the companies should not neglect its internal and external customers in the process.
Filed Under: Companies