External Economies of Scale Overview, Sources, Pros and Cons

external economies accrue due to
external economies accrue due to

There may be a separate head for manufacturing, assembling, packing, marketing, general administration, etc. This leads to functional specialisation which increases the productive efficiency of the firm. Multiple-purpose river development projects are further cases in point. Such projects can provide electric power, flood control, navigable waterways, irrigation, and recreational facilities. In principle, a private group with a charter granting it proprietary rights over an entire river basin could construct and operate an appropriate multipurpose river development project. But such a monopoly would have to be carefully controlled by the state to prevent the private group from exploiting such a powerful ownership right in unsocial ways.

Thus, internal economies accrue only to the individual firm by its own organisational ability and effort. For simplicity, we are assuming that labour is the external economies accrue due to only variable input while other inputs are constant. In this case, there is overproduction of the commodity by the industry than is needed by the society.

external economies accrue due to

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. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.

External Economies of Scale

Regardless of what the effect is, the third party or the external economy has no say in the business‘ actions and there is no official transaction between them. External economies are benefits that are created when an activity is conducted by a company or other type of entity, with those benefits enjoyed by others who are not connected with that entity. The entity that is actually managing the activity does not receive the external economies, although the creation of these benefits for outsiders usually has no negative impact on that entity. The nature of the benefits may include providing inspiration for some new idea, or even something as simple as providing a visual image that the viewer finds appealing. 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.

B) Transport facilities are developed and cost of transport decreases. We can, therefore, conclude that concentration of industries lead to economies of concentration. Therefore, a firm producing on large scale can enjoy economies by the use of superior techniques. In addition to the MLA, Chicago, and APA styles, your school, university, publication, or institution may have its own requirements for citations.

As a result, their productive efficiency falls and serious divergences emerge between social and private costs and benefits. Other instances are of noise nuisance from loudspeakers to neighbours for which the individuals using the loudspeaker does not pay anything to neighbours. According to Pigou, it is self-interest that leads to the equality between private and social costs and returns. In such a setup, all firms can enjoy external economies of scale across industries.

  • It means, price and quantity demanded have negative relationship.
  • We discuss below the various economies of scale which accrue to a firm and an industry.
  • The fiscal deficit is the difference between the total expenditure and total revenue plus market borrowings.

Pollution caused by commuting to work or a chemical spill caused by improperly stored waste are examples of externalities. Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications. Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU. Iii) C – grade land is a marginal land, which earns no rent or surplus.

These externalities lead to misallocation of resources and cause production or consumption to fall short of an optimum level. In the opinion of Prof. Chapman, ‘The external economies are those in which all business firms in an industry can share”. Moreover, the simplest case of an external economy arises when the scale of production function of a firm contains as an implicit variable the output of the industry.

External economies

The expansion of a firm beyond a certain limit may also involve marketing problems. Raw materials may not be available in sufficient quantities due to their scarcities. The demand for the products of the firm may fall as a result of changes in tastes of the people and the firm may not be in a position to change accordingly in the short period. The market organisation may fail to foresee changes in market conditions whereby the sales might fall.

external economies accrue due to

Due to the effect of external economies, the set of cost curves of the firm shifts downward. But due to net economics, the cost curves of all firms will fall. The short run supply curve SS will shift to its new position S’S’, intersecting the demand curve D’D’, balancing industry supply curve and demand at price OP1. In the long run, industry supply will increase from OX1 to OX2. If we join two points K and K’, we get KK’ as the long run supply curve.

Private and Social Costs and Returns (Divergences)

This is simply due to increasing cost industry; higher level of output can be attained only at a higher price. As the number of firms in an area increases, each firm enjoys some benefits like, transport and communication, availability of raw materials, research and invention etc. Further, financial assistance from banks and non-bank institutions easily accrue to firms.

Such facilities increase the efficiency of the workers who help raise the quality and quantity of the products of the industry. Internal economies are internal to a firm when its costs of production are reduced and output increases. They “are open to a single factory or a single firm independently of the action of other firms. The scale of production refers to the amount of factors used, the quantities of products produced, and the techniques of production adopted by a producer. As production increases with the increase in the quantities of land, labour and capital, the scale of production expands. Another variety of external economies may be designated as growth or investment repercussions.

At a particular point real wage rate, the supply of and the demand for labour in the economy become equal and thus equilibrium attained in the labour market. When the number of firms in an industry expands they become mutually dependent on each other. In other words, they do not feel the need of independent research on individual basis. These journals provide information to all the firms, which relate to new market, sources of raw materials, latest techniques of production etc. This results in higher social costs and lower social benefits than private costs and benefits. Individuals who are not in a position to emulate the consumption patterns of their rich neighbours feel dissatisfied and jealous.

External economies and diseconomies are those which accrue to the firms as a result of the expansion in the output of the whole industry and they are not dependent on the output level of individual firms. A firm producing on large scale enjoys the economies of transport and storage. A big firm can have its own means of transportation to carry finished as well as raw material from one place to another.

Pigovian Analysis of Externalities (Explained With Diagram)

The negative slope in demand curve is due to inverse relationship between price and the quantity demanded for the commodity. External economies are those economies which accrue to each member firms as a result of the expansion of the industry as a whole. In the case of external diseconomies of consumption, the state can put an end to noise-nuisance by banning the use of loud speakers except for special occasions with prior permission. In situations of oligopoly or imperfect competition, Pigou favours state regulation of some type or even nationalisation. First, Pigou suggest social control measures to attain the “ideal output” or optimum welfare.

Test: Theory Of Demand- 1

The private product diverges from the social product due to the existence of external economies or diseconomies thereby leading to divergenies between private and social costs and benefits. We analyse these external economies and diseconomies in the light of Pigou’s analysis. The expansion of the industry may also inflict external diseconomies on the single firm. For instance, as the industry expands, scarce infrastructure may get overworked leading to traffic jams, breakdown of vehicles etc.

A large firm also reaps the economies of buying and selling. It buys its requirements of various inputs in bulk and is, therefore, able to secure them at favourable terms in the form of better quality inputs, prompt delivery, transport concessions, etc. Because of its larger organisation, it produces quality products which are offered for sale in attractive packing by its packing department.

We analyse these external economies and diseconomies. Pigou’s major contribution lies in studying the main causes leading to divergences between private and social costs and returns and in suggesting measures for removing these divergences. When the scale of production expands, numerous pecuniary economies accrue to the firm. In markets where efforts are required to sell output, a specialized sales network can be set up, with a corresponding reduction in average selling costs.


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