External Economies Diseconomies of Scale

In addition to internal economics and diseconomies of scale, there are external economies and diseconomies. The external economies are the physical and cost advantages which result from the general development of the industry. When the industry expands, there are advances from occupation division labor and cross-fertilization of ideas. When the industry expands, it offers scope for specialization and skill formation and for lateral and vertical integration. As the growing industry gets localized in a geographical area, facilities are attracted to that area. Simultaneous investments in other industrial activities are induced. These are “external economies in the market sense”. Special technical schools for training skilled labor are established, research institutions are set up; equipment manufacturers build their plants. Ancillary units grow. Interchange of technical information and idea occurs though both formula (professional societies) and informal (golf clubs, etc.) channels. Such external economics are very general in character; all firms within the industry have equal access to them. The external economies do not, therefore, distort competitive elements. In contrast, the internal economies may drive a firm to enjoy monopoly power.

As internal economies may get transformed into internal diseconomies, the external economies may also get converted into external diseconomies. This happens when the industry expands in size indefinitely and the control of industry becomes a problem. Environmental pollution is a good example of external diseconomies as a result of which private as well as social costs of production may increase. In modern times when in most of the countries, industrial development is a planned activity, the responsibility of creating external diseconomies may be largely fixed on the government, particularly its planning unit. The objective of planned industrialization is to maximize the net externalities (= external economies – external diseconomies).

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