Question

Why is expanding not always a good business decision? Give examples of problems on achieved economics of scale? How can they be overcome? Are they always apparent?

Please respond to questions in at least 200 words

Answer 1

Economies of scale is the reduction in total cost of production by a firm or industry by increasing its total output. When a firm expands its production capacity, it decreases the production cost of goods. But as noted economist Adam Smith pointed out that job specialization and labor productivity are two key determinants for economies of scale. Job specialization and labor productivity both are interrelated. Job specialization is the educational qualifications and skills of workers matching the requirements of various jobs. Hiring specialized workers in various processes of a firm increases the labor productivity and economies of scale. However, there are also dis-economies of scale in any production process as expanding business does not always guarantee cost efficiency. Alfred Marshall, a renowned economist described about internal and external economies of scale. Internal economies of scale reflects reduction in total production cost of a firm or industry due to business expansion whereas the external economies of scale is reduction in overall cost of production of a firm due to external factors such as low government taxation, better transportation facilities and reduced energy costs. Internal economies of scale can only be attained if firms are capable of sourcing labor, capital and other resources at cheap rates and efficiently allocate inputs in various production processes. For example, an TV & electronics industry may not attain economies of scale without employing cost effective labor, capital and raw materials. Technological innovation also plays a key role in economies of scale but if acquiring the latest technology is an expensive affairs, then it will need a firm a long time even with expanded production capacity to cover the cost of new technology. Same is the case with external economies of scale. Consider Garment houses that heavily depend on transport sector for shipment of cargo within and outside the country. If there is improper transport networks in rural and remote locations then total cost of production of textiles will rise even with expanded production capacity. This is called external dis-economies of scale. Sometimes, natural calamities also create shortage of raw material supply and delay in transportation of finished products that also generate external dis-economies of scale.

Both internal and external dis-economies of scale in various sectors can be lowered by low taxation policy of government, creating better transport facilities and networks in the country and proper workers' training. The decentralization of a company at various locations will also mitigate rising advertisement and transportation costs of products that will result economies of scale. The dis-economies of scale are not always visible but there is possibility of dis-economies of scale in firms due to uncertain factors such as natural calamities, political instability, global recession etc.