Internal economies of scale
Encyclopedia
'Internal economies of scale
' are a product of how efficient a firm is at producing; they are those economies of scale which a firm has direct control over. They relate to the change in average production cost for a firm as it increases its total output. As output increases, the average cost per unit will fall until the firm reaches its minimum efficient scale, where the firm has maximized its efficiency in production and any additional unit will cause the average cost to rise. In such, a firm in a competitive market will hypothetically produce at its Minimum Efficient Scale (MES); a point where its long run average total cost is the lowest.
An example of a firm utilizing internal economies of scale is when a company is cut in size but the remaining firms still hold the same amount of final output. Therefore the company has become more efficient in production
and has experienced internal economies of scale. The internal part of the business expands enabling the business to make higher profits. They are different from external economies of scale, which focus on an industry as a whole.
Six main types of internal economies of scale can be defined.
Economies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
' are a product of how efficient a firm is at producing; they are those economies of scale which a firm has direct control over. They relate to the change in average production cost for a firm as it increases its total output. As output increases, the average cost per unit will fall until the firm reaches its minimum efficient scale, where the firm has maximized its efficiency in production and any additional unit will cause the average cost to rise. In such, a firm in a competitive market will hypothetically produce at its Minimum Efficient Scale (MES); a point where its long run average total cost is the lowest.
An example of a firm utilizing internal economies of scale is when a company is cut in size but the remaining firms still hold the same amount of final output. Therefore the company has become more efficient in production
Production, costs, and pricing
The following outline is provided as an overview of and topical guide to industrial organization:Industrial organization – describes the behavior of firms in the marketplace with regard to production, pricing, employment and other decisions...
and has experienced internal economies of scale. The internal part of the business expands enabling the business to make higher profits. They are different from external economies of scale, which focus on an industry as a whole.
Six main types of internal economies of scale can be defined.
- Technical economies. They are found mostly in plants and arise mostly because neither the capital cost nor the running cost of plants increase in proportion to their size. The main idea is to spread the fixed costs over as large output as possible, so Average Fixed Cost decreases.
- Managerial or administrative economies arise because the same people can usually manage with bigger output, so average administrative cost decreases when production increases. Large firms can employ specialists, which leads to the increase in efficiency.
- Financial economies arise because e.g. the interest rate for getting a loan is higher for smaller firm that for larger one. This is because large firms have large assets and bank trusts them more. It is also relatively easier for large firms to raise their share-capital by issuing shares.
- Marketing economies. They are available both in purchases of raw material and in selling of the product. A large firm may have a bulk discount when purchasing raw materials. In terms of promotion, to large firms the average cost is smaller, because the prices of advertisements are the same for all firms, hence the large firms can afford costs of sales promotion without causing much difference in their profit shares.
- Social economies. They may be developed into two groups: those that build up the goodwill of the community and so attract customer (sponsorship), and those that develop the loyalty of the firm's employers (Christmas bonuses)
- Risk-bearing economies. They are the firm's ability to bear losses. If one part of the company has a loss, other parts of the company can support it. If the company sustains a loss, it has enough capital to overcome it.