Q.Describe the internal and external economies.
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Start your 14-day free trial to unlock the full solution →Economies are the gains (lower per-unit cost) that accrue to a firm as output expands. Internal economies depend on the firm's own expansion and benefit only that firm; external economies depend on the expansion of the entire industry and benefit all firms in it.
Meaning
As a firm increases its scale of production, its average (per unit) cost of production tends to fall up to a point. These cost advantages are called economies of scale. Alfred Marshall classified them into internal and external economies.
Internal economies
Internal economies arise within the firm because of the increase in its own size and output. They are the result of the firm's own policy and benefit only that particular firm. The main internal economies are:
- Technical economies: large firms can use better, specialised and more efficient machinery and techniques; the law of increased dimensions and superior plant reduce cost per unit.
- Managerial economies: division of management into specialised departments (production, sales, finance) and employment of expert managers improve efficiency and spread managerial cost over more output.
- Financial economies: large firms raise capital more easily and cheaply (lower interest, easier access to the share market) because of their goodwill and security.
- Marketing economies: bulk buying of raw materials at lower prices and bulk selling reduce purchase and distribution costs per unit.
- Labour economies: large scale allows division of labour and specialisation, raising the productivity of workers.
- Risk-bearing economies: large firms diversify products, markets and sources of supply, so losses in one line are offset by gains in another.
External economies
External economies arise outside the firm, from the growth and expansion of the whole industry to which the firm belongs. They are available to all firms in the industry, not just one. The main external economies are:
- Economies of concentration (localisation): when many firms concentrate in one region, they share skilled labour, better transport, banking, power and repair facilities.
- Economies of information: growth of the industry supports trade journals, research bureaus and common market information useful to all firms.
- Economies of disintegration (specialisation): as the industry grows, specialised subsidiary firms spring up to perform particular processes (such as making components) cheaply for all firms.
Internal vs external — key difference
| Basis | Internal economies | External economies |
|---|---|---| …
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