External Economies of Scale and Diseconomies of Scale

Improved management systems and more effective control of labor and operations can lower overhead. External economies of scale describe similar conditions, only for an entire industry instead of a company. A company may specialize in a productive market before deciding to branch out into less profitable markets. Sometimes, laborers become disenchanted in a company and suffer from low motivation if it becomes too large.

The main cause of the internal diseconomies is the lack of efficient or skilled management. When a firm expands beyond a certain limit, it becomes difficult for the manager to manage it efficiently or to co-ordinate the process of production. Moreover, it becomes very difficult to supervise the work spread all over, which adversely affects the operational efficiency.

A small organization faces competition from products of other organizations, whereas sometimes large organizations find that their own products are competing with each other. Refer to economies that arise from the availability of skilled labor, better credit, and transportation facilities. Occur when large organizations employ specialized workers for performing different tasks. These workers are experts in their fields and use their knowledge and experience to maximize the profits of the organization. Refer to real economies which arise from the expansion of the plant size of the organization.

  • The proper response to a lack of direction and coordination is to delegate duties and decision-making to lower levels of the organizational structure.
  • Factors include organizational diseconomies, technical, infrastructural, and financial diseconomies.
  • A similar example is the depletion of a critical natural resource below its ability to reproduce itself in a tragedy of the commons scenario.
  • Diseconomies of scale is a concept used in economics to describe the tendency for average costs to rise in tandem with output.
  • Yet for some businesses, it is necessary to move to such cities in order to expand and attract the necessary talent.

When a company buys inputs or inventory in bulk—for example, the potatoes used to make french fries at a fast-food chain like McDonald’s Corp.—it can take advantage of volume discounts. Patrick Curtis is a member of WSO Editorial Board which helps ensure the accuracy of content across top articles on Wall Street Oasis. Prior to becoming our CEO & Founder at Wall Street Oasis, Patrick spent three years as a Private Equity… This content was originally created by member WallStreetOasis.com and has evolved with the help of our mentors. Prices grow, as a result, making more complicated resource exploitation more viable and advantageous. For example, oil fields in the ocean might be a logistical and expensive headache.

External Diseconomies:

Greater WasteAs a firm gets bigger, there becomes a disconnect between management and the average employee. Consequently, the needs of the worker are often forgone and overlooked. OvercrowdingWhen expanding, the firm may increase production beyond reasonable capacity.

  • Some economies of scale have a physical or engineering foundation, such as the capital cost of manufacturing facilities and friction loss in transportation and industrial equipment.
  • For instance, if a business invests in transportation for a certain industry, the expenses for a business operating in that industry will go down.
  • When economies of scale or diseconomies of scale are location-specific, trade is used to gain access to the efficiencies.
  • At point Q1, this company has the lowest average unit cost if the company produces more or fewer products.

Economists describe the relationship between a company’s size and the cost of producing its goods. There has been a discovery of new and improved production methods. There are more effective modes of communication and transportation. Additionally, accessible skilled labor and workshop facilities have seen growth. Economies like these develop as a result of the industry’s overall growth.

Diseconomies of Pollution

Managers and supervisors have similar issues when organizing operations and ensuring everyone is doing the right thing. These do not always increase the cost-per-unit, but do reduce the ability of a large firm to compete. An agglomeration economy, or synergy, is when businesses in different industries are beneficial to each other and can share resources and opportunities. As a business expands, communication between different departments becomes more difficult. Employees may not have explicit instructions or expectations from management.

Reasons behind External Economies of Scale

Sometimes, big firms can end up paying more than it would as a small company. If we think of Google, Apple, or Microsoft, they all have significant levels of cash flow. For instance, Apple generates revenues of over $55 billion a year. As a result, it is inevitable that such firms end up overpaying for various goods. Employee HealthAs stated previously, employees can feel like just another cog in the wheel of a big firm. However, big firms can also create a feeling of isolation for many.


They will have their own tasks and responsibilities, and managing their delegates is usually not a top priority. In turn, workers may just feel like another cog in the wheel, leaving them demotivated and inefficient. As the industry grows larger, these resources become scarcer, which can put financial pressure on the firms. This may put some competitors out of business, or, the firms may pass on the costs to the consumer. As finance prices rise, so do the costs of keeping financial records. Consequently, if productivity does not improve above these expenditures, the overall cost of production may rise.

The third reason for diseconomies of scale happens when there is a mismatch in the optimum level of outputs within different operations. If production goals and objectives of an organization are not properly communicated to employees within the organization, it may lead to overproduction or production. Refer to economies in which organizations enjoy benefits of buying raw materials and selling of finished goods at https://1investing.in/ lower cost. Large organizations buy raw materials in bulk; therefore, enjoy benefits in transportation charges, easy credit from banks, and prompt delivery of products to customers. External economies and diseconomies of scale are the results of some external causes. The word diseconomies refer to all those losses which accrue to the firms in the industry due to the expansion of their output to a certain limit.

In a discussion about line production and costs, the term “scale” is particularly applicable on both sides of the seller-buyer equation. There is a worldwide debate about the effects of expanded business seeking economies of scale, and consequently, international trade and the globalization of the economy. When coordination difficulties are addressed incorrectly, they reduce productivity.

Other effects which reduce competitiveness of large firms

Due to the price inelasticity of supply, capacity constraints on shared resources and public goods are classic instances of rising input costs. As a firm expands, it may invest in new factories or real estate. If they are not raised appropriately from suitable sources that don’t complement the organization’s structure and philosophy, it might lead to problems (diseconomies). Technical diseconomies of scale can be seen in physical limits on handling and combining inputs and commodities. Two examples are overcrowding and mismatches between the feasible scale or speed of various information and processes.

For example, a new airport may charge a third party for noise pollution. As a result, such companies inevitably overpay for a variety of commodities. Face-to-face encounters may be prioritized over written communication, resulting in less feedback. These can arise for various reasons, the most prevalent of which is the difficulty of managing an expanding workforce. Many professions need employees to perform the same daily tasks from 8 a.m.