INTERNAL ECONOMIES AND DISECONOMIES

Internal Economies and Diseconomies: 

We saw that returns to scale increase in the initial stages and after remaining constant for a while, they decrease. The question arises as to why we get increasing returns to scale due to which cost falls and why after a certain point we get decreasing returns to scale due to which cost rises. The answer is that initially a firm enjoys internal economies of scale and beyond a certain limit it suuers from internal diseconomies of scale. Internal economies and diseconomies are of the following main kinds:

(i) Technical economies and diseconomies: 

• Large-scale production is associated with economies of superior techniques. As the firm increases its scale of operations, it becomes possible to use more specialised and eflcient form of all factors, specially capital equipment and machinery.
•  For producing higher levels of output, there is generally available a more eflcient machinery which when employed to produce a large output yields a lower cost per unit of output. The firm is able to take advantage of composite technology whereby the whole process of production of a commodity is done as one composite unit. 
• Secondly, when the scale of production is increased and the amount of labour and other factors become larger, introduction of greater degree of division of labour and specialisation becomes possible and as a result cost per unit declines. There are some advantages available to a large firm on account of performance of a number of linked processes. 
• The firm can reduce the inconvenience and costs associated with the dependence on other firms by undertaking various processes from the input supply stage to the final output stage. 
• However, beyond a certain point, a firm experiences net diseconomies of scale. This happens because when the firm has reached a size large enough to allow utilisation of almost all the possibilities of division of labour and employment of more eflcient machinery, further increase in the size of the plant will bring about high long-run cost because of diflculties of management.
•  When the scale of operations becomes too large, it becomes diflcult for the management to exercise control and to bring about proper coordination. 

(ii) Managerial economies and diseconomies: 

• Managerial economies refer to reduction in managerial costs. When output increases, specialisation and division of labour can be applied to management. 
• It becomes possible to divide its management into specialised departments under specialised personnel, such as production manager, sales manager, finance manager etc. If the scale of production increases further, each department can be further sub-divided; for e.g. sales can be split into separate sections such as for advertising, exports and customer service. 
• Since individual activities come under the supervision of specialists, management’s eflciency and productivity will greatly improve. Decentralisation of decision making and mechanisation of managerial functions further enhance the eflciency and productivity of managers. Thus, specialisation of management enables large firms to achieve reduction in managerial costs.
• However, as the scale of production increases beyond a certain limit, managerial diseconomies set in. Communication at diuerent levels such as between the managers and labourers and among the managers become diflcult resulting in delays in decision making and implementation of decisions already made. 
• Management finds it diflcult to exercise control and to bring in coordination among its various departments. The managerial structure becomes more complex and is auected by greater bureaucracy, red tapism, lengthening of communication lines and so on. All these auect the eflciency and productivity of management and that of the firm itself.

(iii) Commercial economies and diseconomies: 

• Production of large volumes of goods requires large amount of materials and components. A large firm is able to place bulk orders for materials and components and enjoy lower prices for them. Economies can also be achieved in marketing of the product.
•  If the sales stau is not being worked to full capacity, additional output can be sold at little or no extra cost. Moreover, large firms can benefit from economies of advertising. As the scale of production increases, advertising costs per unit of output fall. In addition, a large firm may also be able to sell its by-products or process it profitably; something which might be unprofitable for a small firm. There are also economies associated with transport and storage.
• These economies become diseconomies after an optimum scale. 
• For example, advertisement expenditure and other marketing overheads will increase more than proportionately after the optimum scale.

(iv) Financiale conomies and diseconomies:

• A large firm has advantages over small firms in matters related to procurement of finance for its business activities. It can, for instance, ouer better security to bankers and avail of advances with greater ease.
•  On account of the goodwill enjoyed by large firms, investors have greater confidence in them and therefore would prefer their shares which can be readily sold on the stock exchange. A large firm can thus raise capital at lower cost.
• However, these costs of raising finance will rise more than proportionately after the optimum scale of production. 
• This may happen because of relatively greater dependence on external finances.

(v) Risk bearing economies and diseconomies:

• It is said that a large business with diverse and multi- production capability is in a better position to withstand economic ups and downs, and therefore, enjoys economies of risk bearing. 
• However, risk may increase if diversification, instead of giving a cover to economic disturbances, increases these.