In microeconomics, economies of scale refer to the benefits involving money saved by the company when production increases. The benefit only happens when the cost per unit decreases and the output manufactured takes the increasing form.
There are two types of economies of scale: internal and external economies of scale. Adam Smith, a Scottish economist, discovered two methods, including specialization of workplace and division of work. This is done to achieve higher productivity, particularly when employees are given specific tasks to do. The latter can help employees improve on their purpose, quickly ensuring greater efficiency.
Economies of scale will also depend on the size of an enterprise. Large businesses will have massive cost benefits and a competitive edge over small firms. This is because the cost per unit depends on the manufacturer’s output.
Internal Vs. external economies of scale
The main distinguishing factor between internal and external economies of scale is that internal economies of scale are the benefits that occur because of the growth of a particular firm that is associated with. On the other hand, external economies of scale are the benefits that happened due to an increasing number of firms in the industry. The first economist to differentiate between the two economies was Alfred Marshall.
He indicated that the economies of scale that a firm can achieve can either be internal and external economies of scale. For you to understand these two terms. You have to understand their meaning. Internal economies of scale are defined by a situation where a firm has reduced the internal costs by its size or by management’s decision. On the other hand, external economies of scale are when external factors affect the overall cost of production.
What are Internal Economies of Scale?
Internal economies of scale will estimate the productivity of a firm and efficiency that can be achieved by increasing their output which is done by decreasing the cost of production. This is common in massive organizations and is of six types. They include;
Technical Economies of Scale are those types of economies of scale that are obtained through the development of production. Production efficiency can be improved by increasing output, and the firm invests in production machinery and equipment.
Managerial economies of scale are achieved when there is a viable or effective workforce. When the firm does well in the market, they are able to hire specialized personnel.
Marketing economies of scale happen when a company markets its products. This means that when the output of a company increases, it can spend more funds on advertisements.
Financial economies of scale are achieved when they have access to financial markets. As the firm grows, they are in a better position credit-wise, and they score better credit ratings. This comes in handy when they want to borrow money as they are favorable in the eyes of the bank.
Commercial economies of scale are attained when the price of your products reduces because of discounts. Firms that are doing well in the market are able to buy goods in bulk which can bring profit in the long run. When they buy these items, they get discounts which reduce their per-unit cost for their product.
Network economies of scale are achieved when the marginal cost of new customers reduces. The company will be able to increase profitability when the company can support new customers. This type of internal economies of scale is suitable for e-commerce and online businesses.
What are External Economies of Scale?
This type of economies of scale is partly achieved by the firm and by economic growth and development. They affect the whole industry concerning the cost of production diminishes, the entire industry thrives. They are of four types, namely;
Infrastructure economies of scale are achieved when public infrastructure is laid down to profit the industry. If numerous companies are situated close by, the government can put forth public infrastructure to meet certain needs of such firms.
Specialization economies of scale are attained when employees focus on a particular industry due to its size. The industry starts to grow more profitable when employees concentrate on a specified industry.
Innovation economies of scale are research that is normally done both in the private and public sectors. As companies gain more ground in the community, they can greatly impact them. Such research allows companies to make informed choices to improve their products and sustainability, which increases profits.
Lobbying economies of scale come about when expanding the bargaining power, making the industry important in the market. Large industries provide job opportunities for the public, and thus governments would always want to keep them. They also pay sufficient taxes. These enable such firms to have huge bargaining power, and hence they are able to put forth terms and conditions that will enable them to make profits.
Difference between Internal and External Economies of Scale
- Internal economies of scale refer to the economies that are internal to a company that fosters an increase in output. In contrast, external economies of scale are factors outside the organization that foster growth in organizations.
- Internal economies of scale can be seen at the average cost curve in the long run but as movements beside this curve. While external economies of scale are seen in the long run at the average cost curve but as a shifting movement along the curve.
- The long-run average cost curve in internal economies of scale will fall only if there’s the development of a manufacturing problem or the size of a company, whereas the long-run average cost curve in external economies of scale goes down because of the development of the industry to some extent.
- Internal economies of scale will reduce costs that allow companies to compete positively against other markets. One main merit of external economies of scale is that companies are not exposed to external threats helping businesses to grow.
- Internal economies of scale are caused by small changes in the firm, whereas external economies of scale are caused by massive changes by outside factors of the firm.
Economies of scale are the advantages associated with a firm’s cost benefits when it grows and the manufacturing product per unit. However, it’s essential to keep in mind that companies that experience expansion due to economies of scale over a long period lead to diseconomies of scale.
Therefore, it is prudent to ensure that firms foster increased economies of scale but look out for diseconomies of scale from not happening to make the firm run long term.