Economies Of Scale

Economies Of Scale

Economies of Scale, the gains in output and/or costs from increasing the size of plant, firm or industry.

Given the prices at which a man can buy the factors of production, there are economies of scale if a less than proportionate physical input is required for a given proportionate rise in output. Alternatively, costs per unit of output may decrease because the prices of factors fall if they are bought in larger quantities.

The nature of the gain from scale can be explained by simple arithmetic. For example, a field 20 yards square and 400 yards in area requires a perimeter fence of 8o yards or half as much as a field 40 yards square and four times this area, or i,600 square yards. Generally, large 'indivisible' units of, e.g. capital equipment or expert advisers or education, market research or other highly specialized departments in a firm, can be employed with maximum profitability only if the scale of activity is large enough to occupy them fully. Benefits from lower prices may result from bulk buying. If the scale of production is not large enough to justify the big units of capital, etc., a smaller plant or �rni is a more economic unit. In other words, even if there are gains from larger size, it does not follow that they will be realized at every possible output in each scale of operations unless the product can be sold. In this sense marketing may be more important than production.

Economies of scale may be internal or external. The former result largely from imperfect divisibility of the factors of production, the latter from expansion of the industry as a whole. Internal economies influence the size and the number of firms in the market They also influence the relative ease or difficulty with which firms can enter an industry and hence the potential as well as actual competition within it. If the most economic scale of production is large, the firms will tend to be relatively few and large. If there are large indivisible requirements in, say, capital for starting up an enterprise, entry will be difficult, and existing firms will be protected from additional competition. Entrants, if any, will tend to be firms already established elsewhere that wish to use theft resources to diversify their interests.

Economies of scale, by reducing the number of firms, is thus one of the reasons for monopoly and oligopoly. Examples are electricity generating, in which much larger generating units have been introduced in recent years; steel-making, in which large blast furnaces and rolling mills are installed in technically integrated works; the motor industry, in which there are big technical economies in large-scale assembly-belt production. Technical economies lead to the building of large factories; where the main economies come from, say, bulk buying or massing of skills, the factories may be small but the firm (comprising a number of factories) large.

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