Economies of Scale

The size and cost of supplied goods are of great importance in international trade. In its turn, it

primarily depends upon economies of scale. By economies of scale economists mean factors which

cause the average cost of producing a commodity to fall as output of the commodity rises. For

instance, a firm or industry which would less than double its costs, if it doubled its output, enjoys

economies of scale.

There are two types of such economies. The first — called internal — accrue to the individual

firm regardless of the size of its industry. They generally result from technological factors which

ensure the optimal size of production is large: (a) With high fixed costs in plant and machinery, the

larger its production, the lower the cost per unit of the fixed inputs. For example, producing steel

without a blast furnace is possible but very expensive; once a blast furnace is built, it is inefficient

only to make small quantities of steel with it: hence, steel companies tend to be large, (b) Large

firms can also arrange for the specialization of labour and machines — as in the techniques of the

production line which can increase productivity. (Smith, A.) (c) Only large firms can afford the

high costs of research and development. Non-technological factors are important too, however.

For example, by buying inputs in bulk, large firms can get discounts from their suppliers (who

grant them because of economies of scale in distributing the supplies). There are also economies of

scale in business finance.

The second type — external economies — arise because the development of an industry can

lead to the development of ancillary services of benefit to all firms: a labour force skilled in the

crafts of the industry; a components industry equipped to supply precisely the right parts; or a trade

magazine in which all firms can advertise cheaply. These can at least partially explain the much

observed tendency for firms to cluster geographically more often than would be predicted from

random location decisions.

The existence of economies of scale in most industries is used to explain the predominance of

large firm s in the world economy, but recently there has been some reassessment of the relative

importance of technological economies of scale as such.