The beginning of this economic concept, economies
of the scale, can be dated back to Adam Smith
who was a Scottish pioneer of political economy and an
important key figure during the Scottish Enlightenment Era
and was based on the idea of obtaining greater production
return profits through the use of the division of labor.
Economies of the scale are referred to as cost advantages that
a company gets by altering its levels of production processes.
The company gets its advantages through economies of scale due to the inverse
relationship that exists between the per unit fixed cost and the quantity produced.
The lesser the quantity of produce, greater
will be the per unit fixed cost of the product.
The implementation of the economies of scale can take place
at any of the firm stages of the production processes
including all the levels economic production of the commodity
except the one that comprises the involvement of the buyer.
Also, a company can implement the economies of scale in its marketing
sector by hiring a large number of marketing professionals.
A company may also involve it in its input sector
by adapting to machine labor over human labor.
The economies of scale are applicable to a variety
of organizational and business institutions at
various units like the business and the manufacturing
unit, input unit or even the entire institution.
When the average cost of the products starts decreasing due to an
increase in the output, the economies of the scale comes into play.
Different types of economies of the scale like the
capital cost of the manufacturing facilities,
the friction loss of transportation and industrial equipment
and others tend to have physical or engineering basis.
The economies of the scale rely on the fixed cost that is uniform and do
not vary with any of the alterations in output processes or variable costs
which may undergo changes due to change in the amount of output.
Other sources of the economies of scale are:
Purchasing: The companies can reduce their average costs by purchasing the inputs
required for the production from the wholesalers or bulk sellers at cheap rates.
Managerial: The companies can reduce their average costs by
adapting to a better management structure within the company.
This can be done by improving the management pattern or through
the hiring of skilled and experienced managerial staff.
Technological: The adaption of companies to a technological advancement may
bring about a major change in the production processes of the company.
Taking the example of the oil industry, fracking
entirely changed the functioning of the oil company.
Financial: The company can reduce their average costs by making a
provision of obtaining low-interest charges when taking loans from a bank
or when the company has access to a wider range of financial instruments.
Marketing: Through marketing, companies can reduce their average costs by spreading
their advertising money over the output processes of the company in the media market.
Economies of scale being a practical concept explain the real-world phenomena
taking place in and around, such as the processes of the international trade,
the number of companies participating and holding a firm place in the market etc.
There are some companies that flourish exceedingly well in the market
and this is due to the exploitation of the economies of scale.
Due to this, free trade policies also flourish
as there are some economies of scale that
have the requirement of a much larger market than what can be provided by the country.
Economies of scale also play an important role in a natural monopoly which
is a monopoly of business in which barriers like high industrial costs,
size of the market etc marks the largest supplier in the industry.
However, the economies of scale also come with some limitations such as the raw
material supply limit such as that of wood in the pulp and paper industry is exceeded,
there has been an increase in the demand of shipping of products over large
uneconomical distances due to low cost of the product per unit weight,
increase in the defect rate of the products and inefficient use of energy.