In this article we will discuss about the reasons leading to economies and diseconomies of scale.
Economies of Scale:
Various factors may give rise to economies of scale, that is, to decreasing long-run average costs of production:
1. Greater Specialisation of Resources:
With an expansion of a firm’s scale of operation, its opportunities for specialisation—whether performed by men or by machines—greatly increase. It is so because a large-sized firm can often divide the tasks and work to be done more readily than a small- sized firm.
2. More Efficient Utilisation of Equipment:
In some industries, the technology of production is such that large units of costly equipment has to be used. The production of automobiles, steel and refined petroleum are obvious examples. In such industries, “companies must be able to afford whatever equipment is necessary and must be able to use it efficiently by spreading the cost per unit over a sufficiently large volume of output. A small-scale firm cannot ordinarily do these things.”
3. Reduced Unit Costs of Inputs:
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A large-scale firm can often buy its inputs—such as its raw materials—at a cheaper price per unit and thus gets discounts on bulk purchase. Moreover for certain types of equipment, the price per unit of capacity is often much less when larger sizes are purchased. For instance, the construction cost per square foot for a large factory is usually less than for a small one. Again the price per horsepower of various electric motors varies inversely with the amount of horsepower.
4. Utilisation of By-Products:
In certain industries, large- scale firms can make effective use of many by-products that would go waste in a small firm. A typical example is the sugar industry, in which by-products like gur and bagasse are made use of.
5. Growth of Auxiliary Facilities:
In certain places an expanding firm often benefit from, or encourage other firms to develop, ancillary facilities, such as warehousing, marketing and transportation systems, thus saving the growing firm considerable costs. For example, commercial and industrial establishments often benefit from improved transportation and warehousing facilities.
Diseconomies of Scale:
With continuous expansion of the scale of operation of a firm, a point may ultimately be reached when diseconomies of scale begin to exercise a more than offsetting effect on the firm’s cost curve starts to rise.
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This is attributable to the following two main reasons:
1. Decision Making Role of Management:
As a firm becomes larger, heavier burdens are placed on management so that eventually this resource input is overworked relative to others, and “diminishing returns” to management set in. In fact, management is an indivisible input which is not capable of continuous variation like labour. With increase in the size of an organisation there occurs delay in decision making.
2. Competition for Resources:
Rising long-run average costs can occur as a growing firm increasingly bids labour or other resources away from other industries. This may raise the prices it pays for its factors and cause increases in its per unit production costs.