Economies of scale are the benefits the firm or industry derives from expanding its scale of production/the advantages of operating on large scale.
There are two types of economies of scale;
- Internal economies of scale
- External economies of scale
Internal economies of scale
These are advantages that accrue to a single firm as its production increases, independent of what happens in the other firms in the industry.
Internal economies of scale result from an increase in the level of output and cannot be realized unless output increases.
The internal economies of scale may be achieved a single plant of the firm or they may arise from an increase in the number of plants.
The internal economies of scale include;
Marketing economies (Buying and selling economies)
These are the benefits which a firm derives from large purchases of inputs or factors of production due to the discounts offered in the process e.g. trade and quantity discounts
The firms may also incur less cost per unit in transportation of the goods bought
Selling economies of scale arise from the distribution and sale of the finished product as the scale of production increases, i.e it is likely to incur less cost per unit in areas such as advertising, distribution e.t.c
- Financial economies;As a firm grows, its assets also increase. These assets can be used as security to borrow money/loan from financial institutions at low interest rates.
Large firms can also raise more funds through selling and buying of shares and debentures.
- Risk bearing economies; Large firms can reduce risks involved in the market failure through diversification of products or markets.
Diversification of markets or products can be done so that;
- Failure of one product is offset the success of other products
- A failure of a product in one part of the market may be offset the success of the same product in another part of the market
-Large scale firms are also able to obtain supplies from alternative sources so that failure in one does not significantly affect the activities of the firm.
iv) Managerial economies/staff economies
Large firms are able to hire/employ specialized staff and management. This increases the firms efficiency and productivity i.e.
- The staff is able to make viable decisions that can go along way in increasing the firms output.
- The firm/management is also able to put in place better organizational structures which allow for departmentalization and subsequent division of labour.Division of labour leads to specialization and hence the overall increase in the firms output.
-the costs of hiring/employing the specialized staff/management are spread over a large number of units of output of variable cost of production.Thus,the cost of labour is minimized when production increases leading to increased profits.
v) Technical economies;
These are benefits that accrue to a firm from the use of specialized labour and machinery. Large firms have access to large capital which they utilize to obtain those machines and hire the specialized labour.The machines use the latest technology and are put to full use, making the firm production more efficient i.e. cost of the machines and labour are spread over many units of output hence less costly but giving higher profits.
vi) Research economies;
Large firms can afford to carry out research into better methods of production and marketing.(Research is necessary because of the increased competition in the business world today) This improves the quality of the products and increases the sales and profits made the firm.
Staff welfare economies;
Large firms can easily provide social amenities to their employees including recreations, housing, education, canteens and wide range of allowances. These amenities work as incentives to boost the morale of the employees to work harder and increase the quality and quantity of output. This leads to higher sales and profits.
A large sized firm can establish warehouses to stock raw materials and therefore enjoy large stocks of raw materials for use when the raw materials are in short supply.Thus, the firm can avoid production stoppages that can be occasioned shortages of the raw materials. The suppliers of such material may be sold at a higher price to realize profit.
External economies of scale;
External economies of scale are those benefits which accrue to a firm as a result of growth of the whole industry. They are realized a firm due to its location near other firms. They include;
- Easier access to labour;Where many firms are located in one area a pool of labour of various skills is usually available. Therefore firms relocating to the area find it easy to obtain.
- Improved/efficient infrastructure;Usually where many firms are located, infrastructure would be highly developed e.g. roads, power, water and communication facilities. Firms relocating in that area thus enjoy the services of infrastructure already in place.
- Firms may be able to dispose off their waste product easily
- Ready market may be available from the surrounding firms
- Readily available services such as banking, insurance and medical care
- Adequate supply of power due to large volume of consumption e.t.c