Scales of

Production
 Contents
1. Introduction 6. Internal Economies
2. Economies of Large Scale 7. External Economies
Production
8. Internal and External Diseconomies
3. Diseconomies of Large Scale
Production 9. Limits to the Expansion of a Business

4. Conclusion
5. The two types of Economies of
Large Scale Production
Introduction
▪ The scale of production has an important
bearing on the cost of production.
Practically the larger the scale of
production the lower is the average cost of
production. That is why the entrepreneur is
tempted to enlarge the scale of production
so that he may benefit from the resulting
economies of scale.
 Economies of Large Scale
Production
1. Efficient Use of Capital
Equipment
2. Economy of Specialized Labor
3. Better Utilization and Greater
Specialization in Management
4. Economies of Buying and
Selling
5. Economies on Overhead
Charges
6. Economy on rent
7. Space for Experiments and
Research
8. Possibility for Advertisement
and Salesmanship
9. Possibility for Utilization of By-
products
10. Better Equipped in Meeting
Adversities
11. Availability of Cheap credit
Diseconomies of Scale

1. Over worked Managed

2. Individual tastes Ignored
3. No Personal Elements
4. Possibility of Depression
5. Dependence on foreign markets
6. Cut-throat competition
7. International complication and war
8. Lack of adaptability
 Conclusion
In spite of the drawbacks large scale production offers several economies. The
tendency in manufacturing and transport industry is to increase the scale.
The advantages out weight the disadvantages. The scale of production is
enlarged till the firm has reached the optimum size. At this scale of
production the total profits is the maximum or the average cost per unit is
the minimum. At this stage the marginal cost is equal to the price (marginal
revenue).
The producer goes on producing more, until the price exceeds the marginal
cost and then stop when the two have been equalized.
“Difference in efficiency between firms will be seen not in the difference in
their marginal costs but in the difference in the output. The more efficient
will have larger output.”
 The two types of Economies of Large
Scale Production
Internal economies are the reductions in production costs, which accrue to the firm itself when it expands its output or
enlarges its scale of production.

▪ The internal economies arise within a firm as a result of its own expansion, independent of the size and expansion of the
industry.

▪ Internal Economies are simply due to the increase in the scale of production which arise from the use of expensive and latest
techniques and technology.

External economies are those economies which accrue to each member firm as a result of the expansion of the whole
industry.

▪ Expansion of an industry may lead to the availability of new and cheaper raw material tools and machinery, because as the
industry grows, subsidiary and correlated firms may spring up in the vicinity of the industry to provide it with raw materials and
tools at reduced prices.

▪ As an industry expands, trade journals may appear which help in the discovery and diffusion of a superior technical knowledge.

▪ And also certain specialized firms may arise which work on the waste materials produced by an existing industry., thus
resulting extra profit.
 Types of Internal Economies
▪ Technical Economies: These arise from the fact that it is easy to make a large machine and there is a mechanical
advantage in the use of large machines. Technical economies pertain not to the size of the firm but to the size of
the a factory or establishment.

▪ Managerial Economies: These economies arise from the creation of special departments or from functional
specializations. The managerial expenses can be reduced by increasing the size of the establishment or by
grouping a number of establishments under one management.

▪ Commercial Economies: These arise from the purchase of materials and scale of goods. Large business have
bargaining advantages and are accorded a preferential treatment by the firms they deal with. They are able to
freight concessions from railways, road transport, cheap credit from the banks, prompt delivery, careful
attention and considerate treatment from all dealers.

▪ Financial Economies: These economies arise from the fact that a big firm has a better credit and can borrow on
more favorable terms . Its shares enjoy a wider market , which encourages a prospective investor. This shows
superior bargaining strength.

▪ Risk bearing Economies :A big firm can spread risk and con often eliminate them. This it does by diversifying
output. Diversification imparts it strength and stability and makes it less vulnerable to changes in commercial
fortunes.
 External Economies
▪ Economies of Concentration: Concentration of firms enables the provision of
better transport and credit facilities , availability of skilled workers, Stimulation
of improvements, benefits from subsidiaries etc. these are the advantages of a
localized industry. Every firm in the industry shares the common stock of
knowledge and experience.
▪ Economies of Information: In a localized industry research and experiments are
centralized. Each individual firm need not incur separate expenditures on
research. It can draw such benefits from the common pool. Such schemes are
beyond the capacity of individual firms and of firms in a scattered industry.
▪ Economies of Disintegration: This is the growth of ancillary industries. When an
industry grows, it becomes possible to split up some of the processes which are
taken over by specialist firms.
 Internal and External
Diseconomies

We should also take into note of the diseconomies, both internal and external.
Thus, as the scale of production increases there are internal economies as well as internal
diseconomies. The internal economies generally out weight the internal diseconomies.
But if the scale of production increases beyond a proper limit the internal diseconomies
will swallow the internal economies as the cost of production will rise instead of falling.
When a firm expands beyond proper limits, it is beyond the capacity of a manager to
manage it efficiently. This is an example of an internal diseconomy.
In the same manner when an industry expands , the firms enjoy external economies. But
disproportionate expansion will result in greater external diseconomies than economies
resulting in a rise in cost of production other than a fall. When an industry expands
disproportionate the competition among the firms gets keener for the factors of
production and raw materials resulting in the price rise of all the raw materials,
machinery and services. This is an example of an external diseconomy.
 Limits to the Expansion of a Business
Although it is profitable to expand business yet it is not always beneficial to do so. Some of the main obstacles in the
growth of a business are as follows:

Financial Obstacles : This is with reference to fresh supplies of capital. Arranging for more capital is not always easy.
But the difficulty is not insurmountable. As it is said that finance is a mere camp follower.

Managerial Obstacles: A point will be reached when the entrepreneur will find that his business has become
unmanageable. Supervision will then become ineffective. Skilled workers will be required. Safeguards against the
fraud will add to the cost. Internal economies will gradually disappear. This is frequently seen in case of indefinite
expansion.

Market Obstacles: These are the usual diseconomies of scale such as competition, need for advertisement , inflation
of factors of production etc.

The firm will go on expanding until the marginal revenue (additional income from the additional output) exceeds the
marginal costs (additional costs incurred on producing the additional output).

Thus, the limit of expansion will be reached when the marginal revenue is equal to marginal costs. At this point the firm
will be maximizing its profits and therefore it will have no incentives to expand its output any further. Hence, this is
the point that the expansion of the business has to be momentarily stopped. In order to stabilize the growth.