Explain the relationship between economies of scale and diseconomies

Difference between Economies and Diseconomies of Scale

explain the relationship between economies of scale and diseconomies

Home» Difference Between Economies of Scale and Diseconomies of The following article provides a good explanation of what each term. Distinguish between economies and diseconomies of scale, giving examples of EACH 1 educator answer; Explain what causes economies of scale. What are Diseconomies of Scale Diseconomies of scale can occur for variety of reasons, but the cause usually comes from the difficulty of managing Diseconomies of scale specifically come about due to three reasons. What's the difference between diminishing marginal returns and returns to scale?.

The total cost of a product is made up of fixed and variable costs. A firm will achieve economies of scale when the total cost per unit reduces as more units are produced. This is because even though the variable cost increases with each unit produced, the fixed cost per unit will reduce as the fixed costs are now divided among a larger number of total products.

What is Diseconomies of Scale? Diseconomies of scale refers to a point at which the company no longer enjoys economies of scale, at which the cost per unit rises as more units are produced.

Diseconomies of scale can result from a number of inefficiencies that can diminish the benefits earned from economies of scale. For example, a firm produces shoes in a large manufacturing facility 2 hours away from its shop outlets.

Such skills are handed down from generation to generation and the expectation is that the child will follow the parent into a particular trade.

For instance, in the West Midlands U. The type of education offered reinforces the industry which dominates the region. External economies also arise from the fact that the service industries in the area develop a special knowledge of the needs of the particular industry and this often leads to the provision of specialised facilities.

Specialised banking, marketing, insurance services will have grown up in the area to deal with the particular requirements of the industry. Ancillary firms provide components and parts for other firms. Such ancillary or subsidiary firms will exist and cater for the needs of the industry of the region.

For instance, in and around Calcutta there are many firms producing components for the engineering industry. A good system of road, rail, air and sea links will be important to all firms in the area and they all share the advantages of the adequate provision of these links. For instance, Mumbai has an airport and is very well-served by motorways, sea and rail links.

explain the relationship between economies of scale and diseconomies

This very fact enables each individual firm to enjoy cost advantages by being able to obtain its components and other requirements at a relatively low cost because they are being mass produced for the industry.

Regional specialisation creates another advantage to the firms located in a particular area. For example, research centres are often established by firms in heavily localised industries on a cost-sharing or, joint venture basis. In practice we observe that in some highly capital-intensive industries, like automobiles, petro-chemicals, oil exploration and steel, the optimum size of the firm is very large notwithstanding the inefficiencies that are likely to arise as the size of the firm increases.

The proximate reason seems to be that in such industries the technical economies are so great that they more than offset any managerial and administrative diseconomies. This is why firms in such industries are getting larger.

Difference Diseconomies of Scale: Because of increasing size, a firm enjoys certain advantages. But, growing size can also bring certain disadvantages.

This means that as the volume of production increases with an increase in firm size, economies of scale yield place to diseconomies of size.

In case of most large firms it is observed that size itself acts as a constraint on growth. Otherwise, there would virtually be no limit to the size of a firm. To put it differently, because of the diseconomies of size, small firms not only tend to survive but flourish in certain trades. In fact, the disadvantages of large-scale production are the advantages of small-scale production. No doubt the present trend in industry is towards the growth of large firms.

But the bigger is not necessarily the better. Various statistical studies in the USA and other industrially advanced countries on the corporate private sector have shown that, in a large number of cases, increases in the scale of production have not yielded the expected benefits in the form of greater industrial and commercial efficiency.

Economies of Scale vs. Diseconomies of Scale

In fact, for each particular industry there will be some optimum size of the firm for which cost per unit or average cost is minimum. If any firm grows beyond this optimum size, its efficiency will decline and cost per unit will rise.

Like economies of scale, diseconomies are of two types — internal and external. A close look reveals that the major cause of diseconomies is management problems.

explain the relationship between economies of scale and diseconomies

It may be noted at the outset that while the usage of land, labour and capital can be increased proportionately in the long run this may not be possible in case of the fourth factor, viz. Diseconomies of scale are usually classified into two categories: Over time these departments not only multiply in numbers but grow in size as well.

Management basically consists of two major functions- decision-making and carrying out implementing the decisions. If the actual number exceeds the optimum number there is likely to be a loss of control in the chain of command, i.

With an increase in the size of the firm there is breakdown of the two-way communication process i. The reason is easy to find out. With an increase in the number of employees it becomes really difficult, in practice, to keep everyone informed of what is required of him her and on what is actually happening in the firm.

Economies of Scale - Definition, Types, Effects of Economies of Scale

Perhaps the thorniest problem for organisations with large numbers of employees is the maintenance of morale. With an increase in the size of the firm it becomes more and more difficult to develop in each worker in a labour force of thousands a sense of involvement and belonging.

The workers fail to identify themselves with the organisation and there is lack of harmony between their interest and the overall organisational goal. Workers feel that they are alien to the organisation. Since workers often regard the firm or the organisation with apathy and sometimes with hostility, the large organisation often becomes a loose organisation.

Rising factor prices also explain why growth in the size of the firm may lead to increasing cost per unit as the size of the firm increases. It may, however, be difficult to obtain increased supplies of some of these factors for example, skilled labour, or minerals from mines which are also working at full capacity. The problem becomes more serious when all firms expand at the same time. Another cause of rising costs per unit with an increase in the size of the firm is rising price of factors of production.

This is an example of external diseconomy. This point may now be discussed. Rising prices of inputs: Businesses also achieve economies of scale by being big enough to afford superior technology, buy in bulk or qualify for special government incentives. A successful large business can also risk more capital and qualify for larger loans than a smaller one. Too Big for Economy Above a certain size, business operations start becoming inefficient.

Difference between Economies and Diseconomies of Scale

It's a lot easier to run "lean and mean" when you're a start-up than when you're a sprawling corporation with a half-dozen plants in a half-dozen state. As inefficiencies increase, growing firms suffer diseconomies of scale.

Introduction to Economics & Diseconomies of Scale - Production - CA CPT - CS & CMA Foundation

Management is a good example of how this can happen. Suppose you start your business with three salespeople and one sales manager.

As business grows, you add three or four salespeople. You get an economy of scale because one manager can still work effectively with all of them. If you keep adding salespeople, eventually the manager won't be able to oversee the entire sales force.