Economies of Scale
Economies of scale arise when the cost per unit falls as output increases. Economies of scale are the main advantage of increasing the scale of production and becoming ‘big’.
When we produce in large quantities generally the production cost reduces. It is the general principle everybody knows. Reduction in the cost of production, when output (production) is increased is called as economies of scale. Large scale of production is economical than small scale of production. Increase in returns to scale (reduction of cost by producing more goods) are caused by real economies, which are classified under
Economies of scale is classified as
This happens when better use is made in factors of production within the firm and by increasing output the factors in the internal economies are as follows.
1. labour economies:
Increase in the scale of production of a firm results into many economies of labour, like specialization. Enlarged scale of production allows division of labour and specialization with the result of an improvement in the skills. Specialisation means to perform just one task repeatedly which makes the labour highly efficient in its performance. This adds to the productivity and efficiency of the labour. Adam Smith illustrated this point with an example. A labourer, all alone can make just 20 pins in a day. But when he divides the work of pin-making into different parts and each part is entrusted to a different labourer then 2400 pins are made in a day.
This is the marvel of division of labour which apart from increasing the skills of labour force, results in (i) Time Saving which is lost in shifting the worker from one job to another (ii) Promotion of New Inventions and (iii) Automation of Production Process. All these increase the productivity of labour and reduces costs.
2. Technical economies:
a) Economies of superior technique
If firm is big it can use high technology (automated machinery) and it can produce high quality goods and cost can be also reduced. Normally small firm cannot use high technology.
b) Economies of increased dimensions:
This is purely mechanical advantage
A big ship is more economical then small ship for transportation
Double Decker is more economical than single Decker for traveling.
A big or small lorry needs single driver, it better to choose big lorry transportation to reduce cost rather than choosing two small Lorries With two drivers.
c) Economies of linked process:
Arranging production process in a correct sequence/order can lead to make Production continuous. Complete production process should be at one place only.
d) Economies of Power:
Uses of Large Machines are more economical than using small machines.
Eg: 10 small machines produce 10,000 units. Whereas one big machinery produces 10,000 units. Here choosing one big machinery is economical than choosing 10 small machines, because power consumed by 10 small machines is more than one big machinery.
e) Economies of continuation:
Production process should be continuous so that the usage of Raw material and other input can be utilized in properly and in efficient manner. Wastage can be reduced.
3. Managerial Economies:
As a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing, human resource management, finance). Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles.
4. Marketing Economies:
If a firm purchase high volume of raw material from the suppliers it cost less, than purchasing small volumes. Employing purchasing expert in the firm to purchase required raw material for the production prevents wastage of excess raw material and it also reduces cost.
5. Financial Economies:
Many small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is often quite high. This is because small businesses are perceived as being riskier than larger businesses that have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at lower interest rates.
Big firm has good advantage in financial matters like
1. Money borrowing (Recognized firms can get money easily from money lenders)
2. Low rate of interest
3. Can easily raise capital (by issuing shares)
6. Risk minimizing Economies:
Producing different types of products by one company has good scope in market rather than producing single variety. Eg: HLL Company produces different types of soaps.
In the words of Cairn cross, "External economies are those which are shared in by a number of firms or industries when the scale of production in any industry or group of industries increases. They are not monopolised by a single firm when it grows in size, but are conferred on it when some other firms grow larger.'
External economies of scale occur when a firm benefits from lower unit costs as a result of the whole industry growing in size. The main types are:
These Economies related to external factors
1. Economies of localization : All firms should be localized to have economies. Different production department should be located at one place. This gives advantage in transportation and in timely labour utilization in production.
2. Economies of information and technical market intelligence : Industry enjoys research advantage, when Management can get whatever the information they want with in short time when firms allocated at one place.
3. Economies of vertical integration: Some industries rather than producing spare parts by themselves, they are purchasing from outside companies. This happens when company feels that buying of parts is cheaper than they produce by themselves.
(Make or Buy decision)
E.g.: TATA Company purchased gear box for cars from kinetic Company
E.g.: Mahindra cars purchasing engine from Renault Company.
4. Economies of Bi products: The firm using one raw material for manufacturing different other products can give more returns (profits) to the firm.
Eg: Amul India , Company producing different food products from milk.