In microeconomics, economies of scale are money-saving benefits companies obtain when production increases. This benefit occurs when the cost-per-unit decreases whilst the output manufactured increases.
Adam Smith, a Scottish economist had discovered two crucial methods, i.e, specialization of workforce and division of work, to achieve a greater yield of production by not only helping personnel focus better on a particular activity but to also help upgrade their abilities to perform jobs quickly and efficiently.
Economies of scale also rely upon the size of the business. Large enterprises usually have greater cost-benefits and a competitive edge as compared to the small companies because the cost per unit generally depends on how much the enterprise manufactures.
Internal vs External Economies of Scale
The difference between internal economies of scale and external economies of scale is that internal economies of scale are the benefits that occur due to the growth of a specific firm that they are associated with whereas external economies of scale are the benefits that arise when there are numerous firms in the industry.
Alfred Marshall, the well-known economist, was the first person to discriminate between the two types of economies of scale which a company can achieve and termed it as internal economies of scale and external economies of scale. Before we get into the differences between the two terms, let’s understand what they mean.
Internal economies of scale relate to when a company internally reduces costs either due to the size of an enterprise or because of the company’s management decisions.
Contrarily, external economies of scale refer to the outside factors that affect the whole industry.
Comparison Table Between Internal and External Economies of Scale (in Tabular Form)
|Parameter of Comparison||Internal economies of scale||External economies of scale|
|Meaning||Occur when there is an increase in the production or the size of the plant.||Occur outside the organization and result in a massive number of growing organizations.|
|Reflected||Reflected as a movement along the LAC curve.||Reflected as a shift in the LAC curve.|
|Long-run average cost curve||Result in a fall of the long-run average cost curve because the output of the firm increases to a definite extent.||Results in a shift downward due to the growth in the size of the industry to a definite extent.|
|Benefits||Reduce the long term costs which helps the organization to upgrade the competition in markets globally.||Help the organization grow in size as it becomes slightly less exposable to external threats.|
|Caused||Based on specific changes caused internally.||Mostly produced externally as they are based on massive changes that happen in a firm.|
What is Internal Economies of Scale?
Internal economies of scale estimate the firm’s productivity and efficiency which can be accomplished by increasing the output when the average cost of the product falls. This is most common in large organizations. There are 6 various types of internal economies of scale and they include:
- Technical economies of scale refer to those internal economies of scale which are attained through development in the production process. The efficiency of the production process can be improved when the output increases and the firm invests in more productive machinery and equipment.
- Managerial economies of scale take place based on the employment of an effective/viable workforce. As the firm does well in the market they can hire more efficient and specialized personnel.
- Marketing economies of scale occur when the firm advertises or markets its products. This implies that as the output of the firm increases the firm can spend a lot more on advertising and can increase its marketing expenses.
- Financial economies of scale can be obtained through access to financial markets. As the firm grows they are said to have a better credit rating and the firm becomes creditworthy. This benefits the firm as when they borrow money from the banks they get a favorable interest.
- Commercial economies of scale can be obtained when the price reduces due to discounts. Large firms who are doing well in the market can buy goods in bulk this in turn brings about a profit to the firm since they get discounts when the firm purchases in bulk and these discounts reduce their per-unit cost of the product.
- Network economies of scale can be obtained when the marginal costs of new customers decreases. The firm can increase its profitability when the firms can support a massive number of new customers. This type of economies of scale is most suitable for online or e-businesses.
What is External Economies of Scale?
External economies of scale are achieved partly by the company and partly by the economic growth and development. External economies of scale have an effect on the entire industry as when the average cost diminishes, the industry thrives. There are four types of external economies of scale and they include:
- Infrastructure economies of scale arise when public infrastructure is put to profit in the industry. When numerous firms of the same industry are located close by, the government increases the public infrastructure to meet the specific needs of the industry.
- Specialization economies of scale occur when the workers focus on a specified industry because of its size. As the industry increases in size, it becomes profitable for workers to concentrate on a specific industry.
- Innovation economies of scale mostly deal with the research that takes place both in the public and private sectors. As industries become more significant they have a huge impact on public interest. This research allows the industry to improve their products and substantially builds their profitability.
- Lobbying economies of scale mainly result in an expansion of bargaining power which then results in industries becoming very important in the market. Governments want to keep large industries as these industries provide a great deal of job opportunities and they pay a sufficient amount of taxes. This gives them bargaining power which is used to negotiate terms to increase the profitability of the industry.
Main Differences Between Internal and External Economies of Scale
- Internal economies of scale refer to the economies that are within or internal to the organization that result in an increase in the output. External economies of scale refer to the economies outside the organization and emerge to an expansion in growing organizations.
- Internal economies of scale can be reflected in the long-run average cost curve as the movement beside the curve. External economies of scale can be reflected in the long-run average cost curve as a shift along the curve.
- The long-run average cost curve of internal economies of scale fall either because of the development in the manufacturing process or the size of an enterprise to some extent. The long-run average cost curve of external economies of scale shifts downwards owing to the development of the industry to some degree.
- The main benefit of internal economies of scale is that the reduction in the costs will help the firm compete positively against international markets. The primary advantage of external economies of scale is that their organization is not exposed to the threats outside the business as it helps the business grow in size.
- Internal economies of scale are based on small changes and are caused by the organization. External economies of scale are caused outside the organization and are based on larger changes.
The above article mainly emphasizes on how the economies of scale is a microeconomic term which refers to the cost-benefits companies acquire when the enterprise grows and manufacturing units increase and also the advantages companies, governments, NPO’s, consumers and governments get from economies of scale. Nevertheless, if the large scale production of a company expands over a certain extent, it may result in diseconomies of scale. Therefore, the firm must ensure an increase in the economies of scale and reduction in the diseconomies of scale to retain the company for a long time.
In this article, we additionally give a gist about the two different types of economies of scale and compare the two of them to give the audience an idea of their meaning and significance as well as which type offers the business a greater competitive advantage.
The piecework also underlines how internal economies of scale happen internally within the specific entity whereas external economies of scale depend upon/set up on the outside changes of the firm. It additionally gives us insights about each topic and the various types under the two economies of scale.