Production may be carried on a small scale or on a large scale by a firm. When a firm expands its size of production by increasing all the factors, it secures certain advantages known as economies of scale or economies of production. Alfred Marshall has classified these economies of large-scale production into internal economies and external economies.
Internal economies:
Internal economies are those, which are opened to a single factory or a single firm independently of the action of other firms. They result from an increase in the scale of output of a firm and cannot be achieved unless output increases. Hence internal economies depend solely upon the size of the firm and are different for different firms.
External economies:
External economies are those benefits, which are shared by a number of firms or industries when the scale of production in industry or groups of industries increases. Hence external economies benefit all firms within the industry as the size of the industry expands.
Internal Economies:
Internal economies may be of the following types.
1) Technical Economies: Technical economies arise to a firm from the use of better machines and superior techniques of production. As a result, production increases and the per-unit cost of production falls. A large firm, which employs costly and superior plant and equipment, enjoys a technical superiority over a small firm. Another technical economy lies in the mechanical advantage of using large machines. The cost of operating large machines is less than that of operating a small machine. Moreover, a larger firm is able to reduce its per-unit cost of production by linking the various processes of production. Technical economies may also be associated when the large firm is able to utilize all its waste materials for the development of the by-products industry. Scope for specialization is also available in a large firm. This increases the productive capacity of the firm and reduces the unit cost of production.
2) Managerial Economies: These economies arise due to better and more elaborate management, which only large size firms can afford. There may be a separate head for manufacturing, assembling, packing, marketing, general administration etc. Each department is under the charge of an expert. Hence the appointment of experts, division of administration into several departments, functional specialization and scientific coordination of various works make the management of the firm most efficient.
3) Marketing Economies: The large firm reaps marketing or commercial economies in buying its requirements and in selling its final products. A large firm generally has a separate marketing department. It can buy and sell on behalf of the firm when the market trends are more favourable. In the matter of buying they could enjoy advantages like preferential treatment, transport concessions, cheap credit, prompt delivery and fine relation with dealers. Similarly, it sells its products more effectively for a higher margin of profit.
4) Financial Economies: The large firm is able to secure the necessary finances either for block capital purposes or for working capital or for working capital needs more easily and cheaply. It can borrow from the public, banks and other financial institutions at relatively cheaper rates. It is in this way that a large firm reaps financial economies.
5) Risk bearing Economies: The large firm produces many commodities and serves wider areas. It is, therefore, able to absorb any shock for its existence. For example, during a business depression, the prices fall for every firm. There is also a possibility for market fluctuations in a particular product of the firm. Under such circumstances, the risk-bearing economies or survival economies help the bigger firm to survive a business crisis.
6) Economies of Research: A large firm possesses larger resources and can establish its own research laboratory and employ trained research workers. The firm may even invent new production techniques for increasing its output and reducing costs.
7) Economies of welfare: A large firm can provide better working conditions in and outside the factory. Facilities like subsidized canteens, crèches for infants, recreation rooms, cheap houses, educational and medical facilities tend to increase the productive efficiency of the workers, which helps in raising productivity and reducing costs.
External Economies:
Business firm enjoys a number of external economies, which are discussed below:
1) Economies of Concentration: When an industry is concentrated in a particular area, all the member firms reap some common economies like skilled labour, improved means of transport and communications, banking and financial services, supply of power and benefits from subsidiaries. All these facilities tend to lower the unit cost of production of all the firms in the industry.
2) Economies of Information: The industry can set up an information centre which may publish a journal and pass on information regarding the availability of raw materials, modern machines, export potentialities and provide other information needed by the firms. It will benefit all firms and reduction in their costs.
3) Economies of Welfare: An industry is in a better position to provide welfare facilities to the workers. It may get land at concessional rates and procure special facilities from the local bodies for setting up housing colonies for the workers. It may also establish public health care units, educational institutions both general and technical so that a continuous supply of skilled labour is available to the industry. This will help the efficiency of the workers.
4) Economies of Disintegration: The firms in an industry may also reap the economies of specialization. When an industry expands, it becomes possible to split up some of the processes which are taken over by specialist firms. For example, in the cotton textile industry, some firms may specialize in manufacturing thread, others in printing, still others in dyeing, some in long cloth, some in dhotis, some in shirting etc. As a result, the efficiency of the firms specializing in different fields increases and the unit cost of production falls. Thus internal economies depend upon the size of the firm and external economies depend upon the size of the industry.
Additional notes:
Block capital: A block refers to a large order of the same security to be bought or sold by institutional or other large investors.
Working capital: A working capital loan is a loan that is taken to finance a company's everyday operations. These loans are not used to buy long-term assets or investments and are, instead, used to provide the working capital that covers a company's short-term operational needs. Those needs can include costs such as payroll, rent and debt payments. In this way, working capital loans are simply corporate debt borrowings that are used by a company to finance its daily operations.
Working capital is a financial metric which represents operating liquidity available to a business, organisation or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Gross working capital is equal to current assets. Working capital is calculated as current assets minus current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. Working capital is the difference between current assets and current liabilities. It is not to be confused with trade working capital (the latter excluding cash).
Reading Lists:
1) Barthwal, R. R. (1992), Microeconomic Analysis (1st Edition). Wiley Eastern Limited, New Delhi, India.
2) Koutsoyiannis, A. (1990), Modern Microeconomics (2nd edition). Macmillan, London.
3) Henderson, J. M. and R. E. Quandt (1980), Microeconomic Theory: A Mathematical Approach (3rd edition). McGraw Hill, New Delhi.
4) Samuelson, P. A., & Nordhuas, W.D (1992), Economics (14th edition). McGraw Hill International edition, U.S.
5) Samuelson, P. A., & Nordhuas, W.D (2013), Microeconomics (19th edition). McGraw Hill Education (India) Pvt. Ltd.
6) Dwivedi, D. N. (2016), Microeconomics: Theory and Applications (3rd edition). Vikas Publication House Pvt. Ltd. Noida (UP), India.
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