Important Differences Between Internal and External Economies of Scale

Internal Economies of Scale

Internal economies of scale refer to the cost advantages that a firm can achieve as a result of increasing its level of output or scale of production. These cost advantages arise from factors that are specific to the firm, and are independent of the moves of other entities in the industry.

Examples of Internal Economies of Scale

Here are some examples of internal economies of scale:

• Technical economies: A bakery that produces more cakes per day can invest in specialized equipment, such as a larger oven or a cake decorating machine, which allows it to produce cakes more efficiently and at a lower cost per unit.
• Managerial economies: A small retail store that expands its operations to multiple locations can hire specialized managers to oversee each store, which allows for better management of inventory, employees, and customer service across all locations.
• Financial economies: A large company can access cheaper sources of finance, such as issuing bonds or obtaining credit from banks, because it has a larger asset base and improved creditworthiness due to its size.
• Marketing economies: A beverage company that produces more cans of soda can benefit from economies of scale in marketing, such as being able to negotiate lower prices for advertising or being able to spread marketing costs across a larger volume of output.
• Purchasing economies: A furniture manufacturer that produces more pieces of furniture can negotiate lower prices for raw materials or components, such as wood or screws, because it can purchase them in larger quantities due to its increased scale of production.

Types of Internal Economies of Scale

There are several types of internal economies of scale:

1. Technical Economies: These arise from improvements in production technology or methods as the scale of production increases. This may include the use of specialized machinery, more efficient production processes, or the ability to benefit from the learning curve as workers become more skilled at their jobs.
2. Managerial Economies: These arise from the ability to employ more specialized and skilled managers as the firm grows, which can lead to greater efficiency and more effective decision-making.
3. Financial Economies: These arise from the ability to access cheaper sources of finance as the firm becomes larger, due to its increased bargaining power and improved creditworthiness.
4. Marketing Economies: These arise from the ability to benefit from economies of scale in marketing and distribution, such as reduced advertising costs per unit as the scale of production increases.
5. Purchasing Economies: These arise from the ability to negotiate better prices from suppliers as the firm becomes larger and its purchasing power increases.
6. Risk-bearing Economies: These arise from the ability of large firms to spread the risk of investment across a wider range of activities, products, and markets.
7. Research and Development Economies: These arise from the ability of large firms to invest in research and development (R&D) activities, which can lead to the development of new products and processes, and improvements in existing ones.

Source of Internal Economies of Scale

Internal economies of scale arise from factors that are specific to the firm, and are independent of the moves of other entities in the industry. These factors can include:

• Technical factors: Such as the use of specialized machinery, more efficient production processes, or the ability to benefit from the learning curve as workers become more skilled at their jobs.
• Managerial factors: Such as the ability to employ more specialized and skilled managers as the firm grows, which can lead to greater efficiency and more effective decision-making.
• Financial factors: Such as the ability to access cheaper sources of finance as the firm becomes larger, due to its increased bargaining power and improved creditworthiness.
• Marketing factors: Such as the ability to benefit from economies of scale in marketing and distribution, such as reduced advertising costs per unit as the scale of production increases.
• Purchasing factors: Such as the ability to negotiate better prices from suppliers as the firm becomes larger and its purchasing power increases.
• Risk-bearing factors: Such as the ability of large firms to spread the risk of investment across a wider range of activities, products, and markets.
• Research and development factors: Such as the ability of large firms to invest in research and development (R&D) activities, which can lead to the development of new products and processes, and improvements in existing ones.

External Economies of Scale

External economies of scale are the cost advantages that arise from the growth and development of the industry as a whole, rather than from the internal factors specific to a particular firm. In other words, external economies of scale are the benefits that a firm receives from being part of a larger industry or economic system.

Examples of External Economies of Scale

Here are some examples of external economies of scale:

• A cluster of clothing manufacturers located in the same area can share suppliers of fabrics and other materials, which can reduce the cost of raw materials for each firm.
• A software development company located in a city with a large pool of skilled programmers can benefit from a wider selection of potential employees, which can help them to hire more talented staff at lower wages.
• A small business located in a shopping district with high foot traffic can benefit from the increased exposure to potential customers, which can lead to higher sales.
• A group of manufacturers located in an area with excellent transportation infrastructure can benefit from lower shipping costs and faster delivery times, which can improve their competitiveness.
• A new technology start-up located in a city with a thriving tech community can benefit from access to a wide range of resources, including investors, mentors, and industry experts, which can help them to grow more quickly and efficiently.

Types of External Economies of Scale

There are several types of external economies of scale, including:

1. Localization economies: These arise from the concentration of firms in a particular geographic area. When firms are clustered together, they can share specialized suppliers, labor pools, and infrastructure, which can lead to cost savings and increased efficiency.
2. Urbanization economies: These arise from the benefits of being located in a large city, such as access to a skilled labor force, specialized suppliers and services, and a larger market for goods and services.
3. Informational economies: These arise from the availability of information and knowledge within a particular industry. As more firms become established in an industry, they can share information about best practices, research, and technology, which can lead to greater innovation and efficiency.
4. Infrastructure economies: These arise from the availability of public goods and services, such as transportation systems, communication networks, and utilities. As the infrastructure in a particular area improves, firms can benefit from reduced transportation costs, improved communication, and greater access to resources.
5. Economies of agglomeration: These arise from the benefits of firms being located close to one another in a large city or region. This can lead to benefits such as access to a large pool of skilled workers, sharing of specialized services and suppliers, and collaboration between firms.
6. Knowledge spillovers: These arise from the sharing of knowledge and ideas between firms in a particular industry. As firms share information about research, development, and best practices, they can all benefit from the resulting innovations and improvements.
7. Institutional economies: These arise from the presence of specialized institutions, such as universities or research centers, in a particular region. These institutions can provide firms with access to specialized expertise and research facilities, as well as opportunities for collaboration and partnership.

Source of External Economies of Scale

External economies of scale arise from factors outside of the individual firm, such as the industry, region, or economy as a whole. Some of the sources of external economies of scale include:

• Localized supplier networks: A cluster of firms located in the same region can benefit from shared access to specialized suppliers and services, such as raw materials or specialized machinery. This can lead to lower costs and improved efficiency.
• Skilled labor pools: Firms located in regions with a large pool of skilled workers can benefit from lower labor costs and improved productivity, as well as access to specialized expertise and knowledge.
• Specialized infrastructure: Firms located in regions with specialized infrastructure, such as transportation or communication networks, can benefit from lower transportation costs, improved communication, and greater access to resources.
• Access to finance: Firms located in regions with a well-developed financial sector can benefit from access to capital at lower costs, as well as specialized financial services and expertise.
• Shared research and development: Firms located in regions with a strong research and development sector can benefit from access to shared knowledge, research facilities, and specialized expertise, which can lead to innovation and improved efficiency.
• Supportive institutions: Firms located in regions with supportive institutions, such as universities or industry associations, can benefit from access to specialized expertise, research facilities, and networking opportunities.

Important Difference Between Internal and External Economies of Scale

Here’s a table comparing important features of internal and external economies of scale:

 Key Difference Between Internal and External Economies of Scale

Here are key differences between internal and external economies of scale:

1. Size of the firm: Internal economies of scale are related to the size of the firm, whereas external economies of scale are related to the size of the industry or economy.
2. Timing: Internal economies of scale can be achieved by the firm at any time, whereas external economies of scale require the growth and development of the industry or economy over time.
3. Control: The firm has more control over internal economies of scale, as they can be achieved through the firm’s own decisions and actions. External economies of scale are largely outside the control of the individual firm.
4. Impact: Internal economies of scale have a direct impact on the firm’s production costs and output, whereas external economies of scale have an indirect impact on the firm’s costs and output through the wider industry or economy.
5. Transferability: Internal economies of scale are generally not transferable to other firms, whereas external economies of scale can be shared by multiple firms within the same industry or region.
6. Risk: Internal economies of scale are generally less risky than external economies of scale, as they are more controllable and less dependent on external factors.

Similarities Between Internal and External Economies of Scale

Although internal and external economies of scale have many differences, there are also some similarities between the two concepts:

1. Both types of economies of scale can lead to cost savings for the firm. Internal economies of scale can reduce the firm’s average costs of production by increasing efficiency and reducing waste, while external economies of scale can reduce the firm’s costs by providing access to shared resources or infrastructure.
2. Both types of economies of scale can lead to increased output for the firm. Internal economies of scale can allow the firm to produce more output at a lower cost, while external economies of scale can increase the availability of inputs or resources, which can lead to higher output levels for the industry as a whole.
3. Both types of economies of scale can contribute to industry growth and development. Internal economies of scale can allow firms to increase their competitiveness and market share, while external economies of scale can lead to the growth and development of entire industries or regions.
4. Both types of economies of scale can be important for firms to remain competitive in the long run. Internal economies of scale can help firms to increase efficiency and reduce costs, while external economies of scale can provide access to specialized resources or knowledge that may be necessary for the firm to compete in its industry.

Conclusion Between Internal and External Economies of Scale

In conclusion, internal and external economies of scale are both important concepts in economics that can lead to cost savings, increased output, and industry growth. Internal economies of scale are achieved through the firm’s internal factors, such as technology, specialization, and production processes. On the other hand, external economies of scale are achieved through external factors, such as shared infrastructure, knowledge, and skilled labor.

While internal economies of scale provide the firm with more control and may be easier to achieve, external economies of scale can provide access to shared resources, knowledge, and specialized inputs that may be necessary for the firm to remain competitive. Firms may need to focus on both types of economies of scale to achieve long-term success and competitiveness.

Overall, the concepts of internal and external economies of scale are important for firms, industries, and economies to understand in order to achieve growth, efficiency, and sustainability.