Q.

4 How to external and internal economies affect returns to

scale?

Ans. Economies scale-

Economies of scale, in microeconomics, are the cost advantages that a
business obtains due to expansion. They are factors that cause a producer’s
average cost per unit to fall as scale is increased. Economies of scale are a
long run concept and refer to reductions in unit cost as the size of a facility,
or scale, increases.

“THE ADVANTAGE OR BENEFITS THAT ACCRUE TO A FIRM AS A RESULT OF INCREASE IN

ITS SCALE OF PRODUCTION ARE CALLED ‘ECONOMIES OF SCALE’.

Accounting to Prof. Marshall these economies are of two types, viz

Internal Economies and External Economics.

Internal Economies:-
Internal Economies of Scale is how efficient a firm is at producing. Internal
economies of scale relates to the change in average production cost for a
firm as it increases its total output. As output increases, the average cost per
unit will fall until the firm reaches its minimum efficient scale, where the firm
has maximized its efficiency in production and any additional unit will cause
the average cost to rise. In such, a firm in a competitive market will
hypothetically produce at its Minimum Efficient Scale (MES); a point
where its long run average total cost is the lowest.
The Following are some of the important aspects of internal economies.

1. They arise “With in” or “Inside” a firm.

 2. They arise due to improvement in internal factors.
3. They arise due to specific efforts of one firm.
4. They are particular to a firm and enjoyed by only one firm.
5. They arise due to increase in the scale of production.
6. They are dependent on the size of the firm.
7. They can be effectively controlled by the management of a firm.
8. They are called as “Business Secrets” of a firm.
KINDS OF INTERNAL ECONOMIES:-
1. Technical Economies - They are found mostly in plants and
arise mostly because neither the capital cost nor the running cost of plants
increase in proportion to their size. The main idea is to spread the fixed costs
over as large output as possible, so Average Fixed Cost decreases.
➢ Economies of superior techniques.
➢ Economies of increased dimension.
➢ Economies of linked process.
➢ Economies arising out of research and by- products.
➢ Inventory Economies.
1. Managerial Economies- Arise because the same people can
usually manage with bigger output, so average administrative cost
decreases when production increases. Large firms can employ specialists,
which leads to the increase in efficiency. Such economies arise in two
different ways,
➢ Delegation of details.
➢ Functional Specialization.
1. Financial Economies- “They arise because of the
advantage secured by a firm in mobilizing huge financial resources”
Financial economies arise because e.g. the interest rate for getting a loan is
higher for smaller firm that for larger one. This is because large firms have
large assets and bank trusts them more. It is also relatively easier for large
firms to raise their share-capital by issuing shares.
2. Marketing Or Commercial economies - They are available
both in purchases of raw material and in selling of the product. A large firm
may have a bulk discount when purchasing raw materials. In terms of
promotion, to large firms the average cost is smaller, because the prices of
advertisements are the same for all firms; hence the large firms can afford
costs of sales promotion without causing much difference in their profit
shares.
3. Social economies- They may be developed into two groups:
those which build up the goodwill of the community and so attract customer
(sponsorship) and those that develops the loyalty of the firm's employers
(Christmas bonuses).
 4. Risk-bearing economies- They are the firm's ability to bear
losses. If one part of the company has a loss, other parts of the company can
support it. If the company sustains a loss, it has enough capital to overcome
it. A large firm secures risk-spreading advantages in either of the four ways –
➢ Diversifications of output.
➢ Diversification of market.
➢ Diversification of source of supply.
➢ Diversification of the process of manufacture.
1. Economies of Vertical integration- “A firm can also reap
this benefit when it succeeds in integrating a number of stages of
production.” It secures the advantages that the flow of goods through
various stages in production processes is more readily controlled. Because of
vertical integration, most of the costs become controllable costs which help
an enterprise to reduce cost of production.

External Economies:-
“EXTERNAL ECONOMIES ARE THOSE ECONOMIES WHICH ACCRUE TO THE FIRMS AS A
RESULT OF THE EXPANSION IN THE OUTPUT OF WHOLE INDUSTRY AND THEY ARE NOT
DEPENDENT ON THE OUTPUT LEVEL OF INDIVIDUAL FIRM.”

The lowering of a firm's costs due to external factors. External economies of

scale will increase the productivity of an entire industry, geographical area or
economy. The external factors are outside the control of a particular
company, and encompass positive externalities that reduce the firm's costs.
The following are some of the important aspects of external economies.
1. They arise ‘outside’ the firm,
2. They arise due to improvement in external factor,
3. They arise due to collective efforts of an industry,
4. They are general, common & enjoyed by all firms,
5. They arise due to overall development, expansion & growth of an
industry or a region,
6. They are dependent on the size of industry,
7. They are beyond the control of management of a firm,
8. They are called as “open secrets” of a firm.

KINDS OF INTERNAL ECONOMIES:-

1. Economies of concentration or agglomeration- They arise

because in a particular area a very large number of firms which produce the
same commodity are established.

2. Economies of Disintegration- These economies will arise as a

result of dividing one big unit in to different small units for the sake of
convenience of management and administration.
 3. Economies of Information- These economies will arise as a
result of getting quick, latest and up to date information from various
sources.

4. Economies of Government Action- These economies will arise

as a result of active support and assistance given by the government to
stimulate production in the private sector units.

5. Economies of Physical Factors- As the size of an industry

Expands, positive physical averment may help to reduce the costs of all firms
working in the industry. For example, climate, weather conditions, fertility of
the soil, physical environment in a particular place may help all firms to
enjoy certain physical benefits.

6. Economies Of Welfare- These economies will arise on account

of various welfare programs under taken by an industry to help its own staff.