Economies of Scale

As the production increases, efficiency of production also increases. The advantages of large scale production that result in lower unit costs are the reason for the economies of scale. There are two types of economies of scale −

Internal Economies of Scale

It refers to the advantages that arise as a result of the growth of the firm. When a company reduces costs and increases production, internal economies of scale are achieved. Internal economies of scale relate to lower unit costs.

External Economies of Scale

It refers to the advantages firms can gain as a result of the growth of the industry. It is normally associated with a particular area. External economies of scale occur outside of a firm and within an industry. Thus, when an industry’s scope of operations expands due to the creation of a better transportation network, resulting in a decrease in cost for a company working within that industry, external economies of scale are said to have been achieved.

Diseconomies of Scale

When the prediction of economic theory becomes true that the firm may become less efficient, when it becomes too large then this theory holds true. The additional costs of becoming too large are called diseconomies of scale. Diseconomies of scale result in rising long run average costs which are experienced when a firm expands beyond its optimum scale.

For Example − Larger firms often suffer poor communication because they find it difficult to maintain an effective flow of information between departments. Time lags in the flow of information can also create problems in terms of response time to changing market condition.