Write a short note on Economies and dis-economies of scale.

The U-shape of the LAC curve reflects the law of returns to scale. According to this law, the LAC curve initially falls as output is increased with change in scale of operation. This shows increasing returns to scale (IRTS). i.e., per unit costs decline as output expands in the long run.

At the minimum point on the LAC, the firm operates with the constant returns to scale (CRTS). Finally, when LAC starts rising, these are decreasing returns to scale (DRTS) as shown in the following diagram:

The reasons for increasing returns to scale causing per unit cost to decline as output increase in the long run are called economies of scale. Economies of scale consists of internal and external economies.

Internal Economies:

The internal economies are built into the shape of the LRAC cost curve because they accrue to the firm as it expands the level of its output. These economies completely depend on the size and efficiency of the firm. These can be classified into four categories namely:

Technical economies : These are the economies which are available because of the use of more modern capital. Large firms can Use specialized and costly tools, implements and machines in various production processes only because scale of production is large and therefore the per unit cost comes out to be less.

Managerial economies : These relate to the Management of the factory. A large sized industry can make use of modern techniques and highly trained and skilled supervisors and expertise. This not only improves the efficiency of the firm but also reduces the cost of production per unit of output. These economies relate to the sale arid purchase of various commodities relating ,to production. A large sized firm .can buy better quality raw materials and other necessary implements at a lower price which reduces his cost of production. Besides, the selling costs of a
big firm are also less. Such a producer avails of various economies in this context such as transport of commodities, advertisement etc.

Financial economies : These economies mean availing of adequate credit facilities at reasonable rate of interest from the market and the financial institutions. These firms can also issue their bonds and debentures which can easily be sold in the market. These facilities are not available to small firms.

Other economies : Big industries have the capacity to sustain conditions of boom. and depression with less discomfort. On the other hand, small industries are closed, when conditions of depression emerge, while big industries can sustain industrial ups and down.

External Economies : External economies arise outside the firm, from improvement (or deterioration) of the environment in which the firm operates.Such economies external to firms may be realized from actions of other firms in the same or in another industry. These are available to the firm not because of its size or efficiency but because of expansion of the industry as a whole. They are completely external to the firm or independent of the actions of the firms.

External economies are available in various forms such as the improvement. in the means of transport and communication in the region will benefit all the firms  in that region. Similarly, if sources of power are made adequate and cheap by the government, these will benefit all the firms. Research centers and laboratories are established and these facilities benefit all the producers.

Dis-economies of scale: 

Decreasing returns to scale resulting in decline in per unit costs in the long run are due to dis-economies of scale. These may arise due to the following reasons :

Managerial dis-economies: Heavy workload, neglect of personal life etc. create physical, mental and psychological pressures on managers. These lead to problems in decision -making and coordination causing decreasing returns.

Exhaustible natural resources: Increasing rate of consumption leads to a decline in the exhaustible natural resources in the world. Examples are exhaustible fish population in sea, rivers and oceans. Similarly, mining and oil resources in a particular area are exhaustible.

Tags: Ba Economics

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