Economies and diseconomies of scale - (Part II)
Yvonne Harvey, Contributor

Patrons at the 2007 Peace Day concert held at the Kingston waterfront, on March 6. - Contributed

Hello everyone. Last week our discussion centred on the Internal economies of scale. This refers to advantages open to a single firm as it expands its scale of production. This week, we will first of all examine the external economies of scale, i.e., the advantages or benefits open to an entire industry that is localised or that has expanded and gone into large-scale production. The lesson will end by considering the internal diseconomies (disadvantages to the firm of large scale production) and the external diseconomies (disadvantages to the entire industry from localisation or large scale production).

External economies of scale

This means that a firm may enjoy certain cost savings not through its own expansion, but by being a part of a well-organised and large industry. The external economies include:

1. Centralised research, education and training facilities are available. All firms in the industry can benefit from such facilities. Thus, firms will find it easy to access information and education and training for staff.

2. Industries that have expanded or that are localised tend to benefit from the development of well-organised markets in which to sell their products.

3. They can benefit from collective advertising, which is cheaper than each firm undertaking its own advertising, e.g., in the Caribbean some collective advertising is done in the tourist industry.

4. Firms in the industry can benefit from centralised maintenance services. The cost of maintenance to each firm will be much less than if each undertook its own maintenance.

5. Transport facilities are also made available to the benefit of all the firms in the industry.

6. A supply of skilled labour may locate in the vicinity of the industry. This will cause firms in the industry to have easy access to the type of labour they need at low costs.

7. Division of labour can take place among the firms in the industry. As we learned in an earlier lesson, division of labour increases output.

8. Bank, insurance, catering, cleaning and other businesses will locate near to the major industry, allowing them to save on costs. Normally, firms will have to pay more for such things if they are not located near them.

Not all expansion, however, produces positive results.

Diseconomies or disadvantages could result. Thus, average costs do not continue to decrease as business expands its output. The diseconomies will be looked at under two headings, internal (disadvantages to the firm of large scale production) and external (disadvantages or drawbacks to the industry of expansion or localisation).

Internal diseconomies of scale

1. The operations of the firm can grow too large for management to control effectively because the lines of communication become more complex. As this happens, waste, confusion, heated arguments and low morale of the workers may result.

2. Specialisation and massive investment in machinery and equipment though leading to increased output, may lead to loss of flexibility necessary to respond quickly to changes in demand.

3. Unnecessary paperwork and administrative staff may be employed, thus increasing costs.

4. As the firm expands, it may be subject to government intervention in the form of price controls or other restrictions. This is especially true if the expansion results in monopolies and oligopolies.

5. Customers may find the larger organisation too impersonal. They prefer the personal touch.

6. Mass production may cause workers to become bored. Ultimately, they may reduce the quality of their work.

7. As firms expand, workers find it easier to form groups such as trade unions. The restrictive practices of such groups may result in increased costs for firms.

8. 'Red-tape' results from expansion of firms. 'Red-tape' refers to elaborate and time-consuming procedures through which customers must go.

9. One of the greatest disadvantages of the growth of firms is the abnormal waste in the factors of production. Because of these disadvantages, a firm should not expand beyond its optimum or most efficient size.

External diseconomies of scale

1. There may be increasing demand in the industry for labour and raw materials. Prices of these will rise and cause a rise in average costs for all firms in the industry.

2. As the number of firms in the industry increases and competition becomes stiffer, more will have to be spent on advertising if the firm is to maintain its position in the market.

3. Localisation of firms in an industry causes pollution and traffic congestion, which impacts negatively on firms in the industry and on society at large.

4. If one or two firms in the industry suffer decline, all other firms in the industry may feel the effects.

That's it for now folks. Next week's topic will be the law of diminishing returns. Bye for now.

Yvonne Harvey teaches at Glenmuir High School.