Internal economies of scale - Part I
Yvonne Harvey, Contributor

This young man washes out a basin in the Rocky Point beach in Clarendon recently. - Ian Allen/Staff Photographer

Good day friends. Our task today is to discuss the advantages of large-scale production firms.

A firm is defined as an independently administered business unit, while an industry is made up of a number of firms producing broadly similar items or items that are connected to one another. Firms and industries may be small scale (small size) or large-scale (large size).

As firms or industries expand and go into large-scale production, they are able to secure certain benefits that are not available to small firms or industries.

These benefits or advantages are referred to as economies of scale and they result in reduced average costs of production as output increases.

Economies of scale are of two types: Internal and external. Internal economies of scale refer to the benefits or advantages to one particular firm as it goes into large-scale production. External economies of scale refer to the benefits accruing to an entire industry that has been localised or concentrated in a particular area. We will now focus on the internal economies of scale.

The types/kinds of internal economies of scale:

Technical

These are often called economies in the use of factors of production. As the scale of production increases, the firm does not have to increase the use of the factors of production to the same percentage or degree as the increase in production. Thus, there is a saving or benefit. For example, output can be increased using the same amount of labour.

This is possible through division of labour, which leads to increased output. In the case of capital, machinery which before was being under utilised, can now be used to its full capacity with very little or no increase in cost.

Managerial economies of scale

Many refer to these as administrative economies. As the firm expands its operations it will not need to expand its administrative staff to the same degree or percentage as the expansion in its operations. In fact, the firm may find that for certain levels of expansion, it may not need to increase the amount of administrative staff at all. This is possible through division of labour and specialisation amongst the managerial staff. The result is increased output of the managerial staff. Managers may specialise in sales, accounting, production or research for instance, eliminating 'red tape' and loss of time.

Marketing

This can be broken down into:

a) buying economies, and b) selling economies.

a) Larger firms are able to purchase their raw materials in bulk, and thereby benefit from cheaper prices through discounts.

b) Larger firms are better able to handle and pay for extensive advertising campaigns. The successful result of such campaigns will be increased demand and greater brand loyalty, both of which will benefit the firm and more than cover the cost of advertising.

Financial

Larger firms have greater capital assets, therefore, it is cheaper and easier to access loans from financial institutions that see them as safer borrowers. They are seen as less likely to become bankrupt and unable to repay their loans thus, banks may actually compete for their accounts.

Research and development

As the firm expands, it becomes better able to afford the highly technical and expensive equipment needed for in-depth experiments. They are also able to afford to employ the services of highly skilled and qualified persons who can develop new methods of production, and save on the costs of production. For example, they may develop a new production technique, which uses simpler or cheaper raw materials. They may also develop new products, which may allow them to compete more effectively with their competitors.

Social

Large firms usually have good customer relations. They are able to develop such because, as they expand, they are able to afford activities that create a good impression of them in the eyes of the public.

Ultimately, they will benefit from increased sales. Expansion may allow them to be able to afford to sponsor sporting events and to give prizes for competitions. They may even be able to afford housing facilities for their employees.

Risk-bearing

As the firm expands, it will be better able to spread its risks by diversifying, that is, selling more than one type of good. The benefit or advantage is that if one product sells slowly or fails, the other products which are successful, will more than cover the shortfall.

Part 2 of the lesson will discuss the external diseconomies of scale and outline the diseconomies of large - scale production.

Now for your homework.

a) Explain the term, 'economies of scale'. (2 marks)

b) Distinguish between 'internal' and 'external' economies of scale. (4 marks)

c) Describe TWO internal economies of scale from which a company could benefit. (4 marks)

Total: 10 marks.

Keep safe, until next week.

Yvonne Harvey teaches at Glenmuir High School.