Internal And External Economies Of Scale
When a company reduces costs and increases production, internal
economies of scale have been achieved. External economies of scale
occur outside of a firm, within an industry. Thus, when an industry's
scope of operations expand due to for example the creation of a better
transportation network, resulting in a subsequent decrease in cost for
a company working within that industry, external economies of scale
are said to have been achieved. With external ES, all firms within the
industry will benefit.
Economies Of Scale
In addition to specialization and the division of labor, within any
company there are various inputs that may result in the production of
a good and/or service:
* Lower input costs: when a company buys inputs in bulk, say for
example potatoes used to make French fries at a fast food chain;
it can take advantage of volume discounts. (In turn, the farmer
from which sold the potatoes could also be achieving ES if the
farm has lowered its average input costs through, for example,
buying fertilizer in bulk at a volume discount).
* Costly inputs: some inputs, such as research and development,
advertising, managerial expertise and skilled labor are expensive,
but because of the possibility of increased efficiency with such
inputs, can lead to a decrease in the average cost of production
and selling. If a company is able to spread the cost of such
inputs over an increase in its production units, ES can be
realized. Thus, if the fast food chain chooses to spend more money
on technology to eventually increase efficiency by lowering the
average cost of hamburger assembly, it would also have to increase
the number of hamburgers it produces a year in order to cover the
increased technology expenditure.
* Specialized inputs: as the scale of production of a company
increases, a company can employ the use of specialized labor and
machinery resulting in greater efficiency. This is because workers
would be better qualified for a specific job, for example someone
who only makes French fries, and would no longer be spending extra
time learning to do work not within their specialization (making
hamburgers or taking a customer's order). Machinery, such as a
dedicated French fry maker, would also have a longer life as it
would not have to be over and/or improperly used.
* Techniques and Organizational inputs: with a larger scale of
production, a company may also apply better organizational skills
to its resources, such as a clear-cut chain of command, while
improving its techniques for production and distribution. Thus,
behind the counter employees at the fast food chain may be
organized according to those taking in-house orders and those
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