Elaborate on the Law of Economies of scale

Economies of scale exist when larger output is associated with low per unit cost. It has been classified into internal Economies and External Economies. (Here Economies are advantages, which a firm or industry will enjoy when they increase the scale of production)

A. Internal Economies –Economies are internal to a firm, when it expands in its size. It is open only for the firm, independent to the action of other firms.

B. External Economies –They are external to the firms, which are available when output of whole industry expands. It is shared by number of firms or industry, when the scale of production increases in any industry.

A. Internal Economies of Scale:

Under internal Economies of scale, there are two categories:

· Real

· Pecuniary

Real Internal Economies of Scale: Real Internal Economies of Scale which arises from the expansion of the firm are:

1. Technical Economies:

In order to produce a commodity in large scale, the firms will install up-to-date machinery. A large firm can utilize the waste material as a by-product by installing a plant for this purpose. Eg. Molasses left over while manufacturing sugar, can be used to produce spirit. They can have the advantage of linked processes. Eg. Sugar producing firms can have their own farms, with their own transport bringing the sugarcane to the factory and their own distribution system to send it to the market. Thus, they enjoy the economies of linked processes.

2. Marketing Economies:

A firm enjoys the advantage of buying and selling, as the requirement is in bulk because they are able to get favorable terms, in form of better quality input, transport concessions etc. these economies are due to large scale of production, as they have strong bargaining power.

3. Managerial Economies: A large firm can afford specialist to be managers and supervisors for all the departments like, sales manager for sales department, production manager dealing with the production department and so on. This brings more efficiency and leads to functional efficiency.

4 Risk Managerial Economies: Large firms are in a better position to spread risk. They can diversify their products and counter balance the loss in one product by gains from the other product. They can even diversify their market by selling their product in many markets and counter the loss in market by gains in the other market.

5 Economies of Welfare: Many firms provide welfare facilities to their workers. They provide better working conditions in and out of factory by providing canteen, crèche for the infants of women workers, recreational club, health and medical facilities to the families of the workers..

B External Economies of scale:

In External Economies of scale, again we have two categories:

· Real

· Pecuniary

Real External Economies of Scale: It represents how a firm is benefited in an industry through technological interdependence of firms. The external economies are:

1. Technical Economies:

When any industry expands, firms in that industry start with different types of processes and the whole industry is benefited. Eg. In textile industry, some firms start specializing in manufacturing thread, some in printing, some in dying, others in shirting, etc.

2. Economies of Information:

An Industry is in a better position to set up research laboratories as they are able to gather large resources. The work of the research may be some now invention and the information about it will be given to all the firms through the journals. The industry can have their own information centre, which gives information regarding the export potentials, modern technology and information. This can be useful for the firms by publishing in the journals. This in turn helps the efficiency and productivity of the whole industry.

1. Economies of By-Product:

Many industries turn out large waste materials, which can be used as input in process of manufacturing, like iron-scarps in steel industry, molasses in the sugar industry, etc. New firms can enter the industry and use these waste materials to produce by-products. They can purchase the raw material at reasonable rates. It gives them the advantage of waste management, the expenses of disposing off waste and they can earn certain amount by selling their waster material.