Difference Between Internal and External Economies of Scale

Edited by Diffzy | Updated on: September 21, 2022

       

Difference Between Internal and External Economies of Scale Difference Between Internal and External Economies of Scale

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Introduction

Economies of scale may be defined as cost advantages reaped by companies when production becomes efficient. Economies of scale are achieved by a company by increasing production and lowering costs. This happens as costs (both fixed and variable) are spread over a more significant number of products. Economies of scale are an essential concept for any business entity operating in any industry. They represent the cost savings and competitive advantages larger businesses have over smaller firms. The size of the company always plays a significant role when it comes to economies of scale. As the size of the business increases, the cost of savings also increases. Economies of scale may be internal or external. Internal economies of scale are the economies of scale that are based on management decisions, whereas external economies of scale are based on outside factors. Internal economies of scale are the economies of scale that arise on account of an increase in the scale of production and plant size.  External economies of scale are those economies of scale that occur outside the entity and accrue to the growing entities. This article attempts to explain both internal and external economies of scale as well as draw the critical differences between the two terms both in a tabular form and in points.

Internal Economies of Scale vs External Economies of Scale

The critical difference between internal economies of scale and external economies of scale is that internal economies of scale are the advantages that occur due to the growth of a particular firm that they are associated with, while external economies of scale are the advantages that arise when there are several firms in the same industry. Internal economies of scale occur when a corporation cut costs internally. This implies that internal economies of scale are unique to that firm. This may be because of the sheer size of a corporation or because of decisions made by the firm's management. Large companies may be able to achieve internal economies of scale by lowering their costs and raising their production levels since they can buy resources in bulk, have unique technology, or they can access more capital. However, external economies of scale are achieved because of external factors, i.e., factors that affect the entire industry. This implies that no one company controls costs on its own. These occur when there is a highly-skilled labour pool, subsidies and/or tax reductions, and partnerships and joint ventures, in short, anything that can cut down on costs to many companies in a specific industry.

Difference Between Internal Economies of Scale and External Economies of Scale in Tabular Form

Table: Internal Economies of Scale vs External Economies of Scale
Parameters of Comparison
Internal Economies of Scale
External Economies of Scale
Definition
Internal economies of scale are defined as those economies of scale that arise due to an increase in the scale of production and equipment/machinery.
External economies of scale are defined as those economies of scale that arise outside the entity and accrue to the growing entities.
Influenced by
Internal economies of scale are generally based on decisions made by the management of the firm.
External economies of scale are based on outside factors.
Effect on the long-run average cost curve.
Internal economies of scale are reflected by a movement along the long-run average cost curve.
External economies of scale are reflected by a shift along the long-run average cost curve.
Advantages
Internal economies of scale aid in reducing the long-term costs, which help the organization to upgrade themselves in the competition in global markets.
External economies of scale help the organization grow (in size) since it becomes less prone to external threats.
Caused by
Internal economies of scale are caused due to specific changes caused internally within the organisation.           
External economies of scale are caused externally since they are based on massive changes that take place that is beyond the control of the firm.
Reason for change in the long-run average cost curve.
The long-run average cost curve ( LAC curve) of internal economies of scale falls either because of the developments in the process of manufacturing or because of the size of the enterprise.
The long-run average cost curve ( LAC curve) of external economies of scale shifts downwards owing to the industry's development to some degree.
How it is achieved
Internal economies of scale are achieved by lowering costs and raising production levels by buying resources in bulk, using unique technology, or utilising more capital.
External economies of scale are achieved when there is the availability of a highly-skilled labour pool, subsidies and/or tax reductions, and partnerships and joint ventures.

What are Internal Economies of Scale?

Internal economies of scale are those that arise on account of an increase in the scale of production and plant size.  Internal economies of scale happen when a company cuts costs internally. This essentially means that they are unique to that firm. This may be caused due to the sheer size of a company or because of decisions made by the management of the firm. Large companies may be able to achieve internal economies of scale by lowering their costs and raising their production levels. This is because they can buy resources in bulk, employ unique technology, or because they have access to more resources and capital.

Types of Internal Economies of Scale

  1. Technical economies of scale- this refers to those internal economies of scale that are attained via developing the production process. The efficiency of the production process may be improved when the output produced increases, and the firm invests more in productive equipment and plant.
  2. Managerial economies of scale- this takes place depending upon the employment of an effective workforce. As the firm performs well in the market, they become capable of hiring more efficient and specialized personnel.
  3. Marketing economies of scale- these occur when the firm advertises or markets its products. This implies that as the output of a firm increases, it can spend more finance on advertising and also become capable of increasing its marketing expenses.
  4. Financial economies of scale- can be obtained by accessing financial markets. As the firm grows in terms of its size and goodwill, it tends to have a good credit rating. This implies that the firm becomes creditworthy. This benefits the firm when they borrow money from the banks, as they get a favourable rate of interest.
  5. Commercial economies of scale- these can be obtained when the firm reduces the price of its products on account of discounts. Large firms that are performing well in the market buy goods in bulk. This brings about a profit to the firm since they get discounts while purchasing in bulk, and these discounts also reduce the cost of the product per unit.
  6. Network economies of scale- these can be obtained when the marginal costs of new customers decrease. The firm may increase its profitability when it can support a significant number of new customers. This type of economy of scale is most suitable for business conducted online.

What are External Economies of Scale?

External economies of scale are defined as those economies of scale that arise outside the entity and accrue to the growing entities. External economies of scale are those economies of scale that occur outside the entity and accrue to the growing entities. They are achieved because of external factors, i.e., factors that affect the entire industry. This implies that no one company controls costs on its own. These occur when there is a highly-skilled labour pool, subsidies and/or tax reductions, and partnerships and joint ventures, in short, anything that can cut down on costs to many companies in a specific industry.

Types of External Economies of Scale

  1. Infrastructure economies of scale- arise when public infrastructure is utilised to earn a profit. When several firms of the same industry are located close by, the government increases the public infrastructure to meet the needs of that industry.
  2. Specialization economies of scale- these occur when the workers focus on a particular industry because of its size. As the size of the industry increases, it becomes profitable for workers to concentrate on a specific sector.
  3. Innovation economies of scale- they majorly deal with the research that takes place in both public and private sectors. As the significance of industries increases, they have a significant impact on public interest. This research allows the industry to improve its products. This essentially builds their profitability.
  4. Lobbying economies of scale- mainly result in an expansion of bargaining power. This further results in industries becoming more significant in the market. Governments want to keep large enterprises since they provide a vast number of job opportunities, and they pay a substantial amount of taxes. This gives them the bargaining power that is used to negotiate terms to increase the profitability of the industry.

Advantages of External Economies of Scale

  1. Equitable-All firms in an industry enjoy these economies of scale equally.
  2. Growth- External economies of scale can speed up the growth of the industry in specific regions. They also encourage the rapid economic development of supporting industries and even the entire city.
  3. Lowers costs- In addition to lower production costs and operating costs, economies of scale even reduce variable costs per unit cost of the product. This is because of operational efficiencies and synergies.

Main Differences Between Internal and External Economies of Scale In Points

  1. Internal economies of scale are those economies of scale that arise on account of an increase in the scale of production and equipment/machinery. External economies of scale are those economies of scale that arise outside the entity and accrue to the growing entities.
  2. Internal economies of scale are influenced by management decisions, while external economies of scale are influenced by outside factors.
  3. Internal economies of scale are reflected by a movement along the long-run average cost curve, whereas external economies of scale are reflected by a shift along the long-run average cost curve.
  4. Internal economies of scale aid in reducing the long-term costs, which help the organization to upgrade themselves in the competition in global markets, while external economies of scale help the organization grow (in terms of size) since it becomes less prone to external threats.
  5. Internal economies of scale are caused due to specific changes caused internally within the organisation, whereas external economies of scale are caused externally since they are based on massive changes that take place that is beyond the control of the firm.
  6. The long-run average cost curve (LAC curve) of internal economies of scale falls either because of the developments in the process of manufacturing or the size of an enterprise to some extent. On the other hand, the long-run average cost curve (LAC curve) of external economies of scale shifts downwards because of the development of the industry to some degree.
  7. Internal economies of scale are achieved by lowering costs and raising production levels, by buying resources in bulk, using unique technology, or utilising more capital, while external economies of scale are achieved when there is the availability of a highly-skilled labour pool, subsidies and/or tax reductions, and partnerships and joint ventures.

Conclusion

Economies of scale are referred to as cost advantages reaped by companies when production becomes efficient. Economies of scale can be achieved by a company by increasing production and lowering costs. Economies of scale can be both internal and external. Internal economies of scale are generally based on decisions of the management of the firm, whereas external economies of scale are based on outside factors. Internal economies of scale are those economies of scale that arise on account of an increase in the scale of production and plant size. External economies of scale are those economies of scale that occur outside the entity and accrue to the growing entities.

Both internal economies of scale, as well as external economies of scale accrue to the firm only up to a certain level; after then, the long-run average cost curve begins to rise when this level is crossed. This often leads to internal and external diseconomies of scale. This article has attempted to explain the significant differences between internal and external economies of scale. It has further described the concept of internal economies of scale and their types, as well as the idea of external economies of scale, their types and advantages.


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"Difference Between Internal and External Economies of Scale." Diffzy.com, 2022. Sun. 25 Sep. 2022. <https://www.diffzy.com/article/difference-between-internal-and-external-economies-of-644>.



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