Diseconomies Of Scale

Diseconomies Of Scale

Diseconomies of Scale, the conditions inside or outside a firm that explain the rise in (average) costs resulting from an increase in the scale of operations. Economies of scale leading to reduced cost per unit of output arise largely because a firm as it grows can take increasing advantage of 'indivisible' factors of production such as highly specialized machinery. Long-run unit costs do not continue to fall indefinitely because after a point conditions inside or outside the firm give rise to diseconomies of scale which slow down or reverse the fall in unit costs.

Some economists have argued that diseconomics of scale eventually occur mainly because of growing difficulties in management. For example, as a firm run by a single head expands, it will become more difficult for him to know what is happening and to take decisions. If there is one unit with a works manager and a further unit is set up with a second works manager, a general manager will be needed to co-ordinate the two units.

Up to a point there may be gain from increasing scale as the opportunity arises to employ good executives and advanced manage-ment techniques. But as the organization grows a disproportionately large number of people is involved in management, and the effective span of control of individual managers is limited because control and accountability become difficult; inertia and vested interests hamper initiative; and communications become more costly.

Some economists have argued that diseconomies can be offset by delegation and decentralization, and that there is no necessary limit to size. It is true that improvements in management aids and methods can increase the size which is most efficient, and there is a trend towards larger average size in many industries. But business is increasingly exercised by the problems of coping with size.

Diseconomies that are 'external' to individual firms may also ultimately raise unit costs. If an industry as a whole is expanding, its growing demand for the factors of production may eventually drive up their prices: regional expansion of a number of industries may bring congestion and bottlenecks in supplies of factors and the distribution of goods. Where firms supplying components run into internal diseconomies they appear as external diseconomies to the firm supplied by them. The continuing existence of small firms in engineering, building, farming, retailing and elsewhere is explained in part by diseconomies of scale.

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