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Home » Economics Homework Help » Microeconomics Help » Economies in Production
Economies in Production
External economies

As the firm expands its scale of production, it becomes possible for the firm to produce a unit of product at a relatively lower cost due to internal economies of large scale production. On the other hand, external economies occur when the expansion of a firm’s output creates benefits, part of which goes to others. A firm may create external benefits for others in two ways: (a) by expanding production, the firm may render a direct service to other firms such as training the labourers by its power training programme and thus benefit the other firms by making available skilled and trained and trained labourers when they have to any no cost or only nominal cost. (b) by expanding its producing a firm may make the supply of some inputs cheaper for all the firms in the industry.

For example, an expansion in the production of an engineering firm may increase the demand for steel. And if the steel production is subject to internal economies of large scale production, the expansion of steel industry following the increase in its demand will lower its cost and price. Another example of external economies is provided by the construction of a bridge or a highway which reduces transport cost and increases the land values in the neighbouring areas. Still another example of water from mine A, it will lower the cost of pumping water from mine B owned by another firm. Similarly, bees of pollinate oranges in the grooves. On the other hand, orange grooves create external economies for the honey producers since the orange grooves provide nectar for the bees producing honey.

In all cases, a firm incurs cost in its expansion but the benefits arising out of it are also reaped by others who pay no price for them.

External diseconomies

Let us explain some external diseconomies of production. There are a good number of external diseconomies which may be created by the productive activity of a firm. The pollution of air by the factories through smoke and the wastes of factories poured into streams or ocean create health hazard for men, especially those who live in the surrounding areas. For these external harms caused to the other members of the society, the firms are not required to pay any price. A factory owner pays nothing to the residents of the neighbouring colony who happen to be the victims of pollution by the factory. Another example of external diseconomies is provided by a firm or industry which has to keep more trucks on the road to do its business. This will overcrowd the road which will increase the transportation costs of other firms or industries which had to carry their own goods by trucks. The expanding firm or industry does not pay any price for the higher transport cost incurred by others.

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