The economies of scale can be grouped as:
(a) Internal Economies.
(b) External Economies.
Now a word about them.
(a) Internal Economies:
Internal economies are those economies in production—those 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 as a whole.
It should be carefully noted that the internal economies are simply due to the increase in the scale of production. That is why they are also called Economies of Scale. They arise from the use of methods which small firms do not find it worth-while to employ.
Internal economies may be of the following types:
(a) Technical Economies:
They arise in three ways: Firstly, when production on a large scale is to be undertaken, better techniques can be adopted, e.g., using a spinning machine instead of a ‘charkha’. Secondly, the bigger the machine the more economical it is, e.g., a, 10 H.P. engine is 5 times as powerful as a 2-H.P. engine but is not five times as costly. Thirdly, economies also arise from the linking of the processes (vertical combination) and from specialisation.
(b) Managerial Economies:
These economies arise from the creation of specialised departments or from functional specialisation. They also result from the delegation of routine and detailed matters to subordinates.
(c) Commercial Economies:
They arise from the purchase of materials and sale of goods. Large businesses have bargaining advantages and are accorded a preferential treatment by the firms they deal with.
(d) Financial Economies:
These economies arise from the fact that a big firm has better credit and can borrow at more favourable rates. Its shares enjoy a wider market which encourages a prospective investor.
(e) Risk-bearing Economies:
A big firm can spread risks and can often eliminate them. This it does by diversifying output. Diversification imparts it strength and stability and makes it less vulnerable to changes in commercial fortune. There is also diversification of markets, of sources of supply, and of processes of manufacture.
(b) External Economies:
External economies are those economies which accrue to each member firm as a result of the expansion of the industry as a whole. An expansion of the industry’ may lead to the availability of new and cheaper raw materials, tools and machinery, and to the discovery and diffusion of a superior technical knowledge. Some raw materials and tools may be made available at reduced prices, because as the industry grows, subsidiary and co-related firms may spring up in the vicinity of the industry to supply it raw materials and tools at reduced prices.
Further, as the industry expands, trade journals may appear which help in discovering and spreading technical knowledge. Besides, with the expansion of the industry, certain specialized firms may come into existence which work lip its “waste products.” The industry can then sell them at a good price. Thus, the entry of firms enlarging the size of the industry may enable all firms to produce at a lower cost.
The large-scale firm reaps internal economies. The large-scale industry brings to the constituent firms external economies. There is very possibility of external economies to be reaped when a young industry grows in a new territory.
External economies are not a peculiar property of any particular business. They are known to all and shared by all. These economies are generally available to a localised industry, where certain developments confer common advantages on all firms, such’ as’ advantages of specialised transport, trained labour credit facilities, etc.
Practical examples of external economies will be found in the classification of such economies given below:
(a) Economies of Concentration:
These economies relate to advantages arising from the availability of skilled workers, the provision of better transport and credit facilities, stimulation of improvements, benefits from Subsidiary industries, arid so on. Scattered firms cannot enjoy such economies.,
(b) Economies of Information:
These economies refer to benefits which all firms engaged in an industry derive from the publication of trade and technical journals and-from central research institutions.
(c) Economies of Disintegration:
When an industry grows, it becomes possible to split up some of the processes which are taken over by specialist firms for example, a number of cotton mills located in a particular locality may have thebenefit of a calendaring plant.
No hard and fast line can be drawn between internal and external economies. When a number of firms combine external economies become internal economies. Whether particular economies are internal or external simply depends upon what operations it is profitable to combine. It is worth nothing that as commercial and technical education spreads, and other such developments take place, the field of internal economic is being narrowed and that of external economies is being widened. This is the result of progress in different fields.