Economies of Scale 1

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Published on February 17, 2014

Author: chandupulapa

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Economies of Scale: Economies of Scale By chandrasekhar Meaning : Meaning Economies of scale refers to the phenomena of decreased per unit cost as the number of units of production increase. The initial investment in capital is diffused through an increase in production, and the marginal cost of producing a good or service decreases when each additional unit of production is added. Economies of scale means a reduction in the per unit costs of a product as a firm's production increases. Where do Economies of Scale Occur Most?: Where do Economies of Scale Occur Most? Economies of scale tend to occur in industries with high capital costs in which those costs can be distributed across a large number of units of production (both in absolute terms, and, especially, relative to the size of the market). A common example is a factory: An investment in machinery is made, and one worker, or unit of production, begins to work on the machine and produces a certain number of goods. If another worker is added to the machine he or she is able to produce an additional amount of goods without adding significantly to the factory's cost of operation. The amount of goods produced grows significantly faster than the plant's cost of operation. Hence, the cost of producing an additional good is less than the good before it, and an economy of scale emerges. Types of Economies of Scale: Types of Economies of Scale Internal Economies of scale External Economies of scale Internal Economies of Scale: Internal Economies of Scale These are economies made within a firm as a result of mass production. As the firm produces more and more goods, the average cost begin to fall because of: Technical economies made in the actual production of the good. For example, large firms can use expensive machinery, intensively. Managerial economies made in the administration of a large firm by splitting up management jobs and employing specialist accountants, salesmen, etc. Financial economies made by borrowing money at lower rates of interest than smaller firms. Marketing economies made by spreading the high cost of advertising on television and in national newspapers, across a large level of output. Commercial economies made when buying supplies in bulk and therefore gaining a larger discount. Research and development economies made when developing new and better products. External Economies of Scale: External Economies of Scale External economies are those economies which accrue to firms as a result of expansion in the output of whole industry and they are not dependent on the output level of individual firms. Cheaper raw material and capital equipment: Cheaper raw material and capital equipment Expansion of industry results in exploration of new and cheaper source of raw material , machinery and other types of capital equipment. These results their cost of production and hence there price. Technological external economies: Technological external economies When whole industry expands , it may result in discovery of new technical knowledge from this improved and more competent machinery can be used This will enhance the production and productivity of firms in the industry and reduce their cost of production. Development of skilled labor : Development of skilled labor When an industry expands in an area the labor in that area will is well accustomed to do various productive processes and learns a good deal from experience . Which has a favorable effect on the level of productivity and cost of the firm in that industry Growth of dependent industries :  Growth of dependent industries With the growth of industry a number of dependent industries may specialize in production of raw materials , tools and machinery they can provide them at a lower price to main industry This will tend to reduce the cost of production in general Better transportation and marketing facilities : Better transportation and marketing facilities The expansion of industry resulting of entry of new firms may make possible and development of transportation and marketing network to a great extent which will greatly reduce cost of production of the firms Similarly communication system may get modernized resulting in better and speedy information Economies of Scale in Agriculture: Economies of Scale in Agriculture The exploitation of economies of scale helps explain why companies grow large in some industries. Agriculture in Canada represented an excellent opportunity to capture the benefits of economies of scale. Farmers found that by increasing the factors of production (mechanization, larger farms, better seed, more fertilizer & pesticides, better farming techniques etc.) their productivity increased significantly. The productivity of Canada farms grew enormously and the unit cost of food for the consumer fell sharply. The demand for food did not grow as fast as its production. People would rather spend their extra money on other goods and services. As farms grew larger and more capital intensive (mechanized), the number of farm workers declined sharply while the opportunities and wages in the urban areas grew significantly. Moderation may be the best Policy: Moderation may be the best Policy As with everything life moderation does seem to be the rule of thumb. Economies of scale must be understood and growth in some industries works fine while in others it may be best to stay small and find those niche markets. Examples: Organic Farming Unique production items: art Thank you: Thank you

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