External Economies of Scale

The long run average cost curve can move on its own, without the firm producing any more or less. Spooky right?…..

But no, it’s not paranormal activity at play, nor Arthur Andersen doing your accounts…

It’s the phenomenon known as external economies of scale.. In other words, firms costs can change simply because the industry itself is growing or shrinking..

That means the LRATC can shift up or down. Let’s find out how this can happen….

External Economies of Scale

This can happen in many ways, and you can imagine how if the market you work in is building, you will benefit too. Here are the main ways:

Technology Incentives

If a market is building, then anybody who can find an innovation for it will sense big money.

This creates incentives to do so and thus reduce overheads through us Economist’s use of classic rational economic man

An example is the still booming online economy: As it’s got bigger we see faster and faster product development to make use easier, for example browser evolution.

Information Sharing

With an expanding industry, there will be more media through which a business owner can search and apply the advice of others in journals etc.

The general labour force may start to be schooled to know the industry’s workings when it is no longer niche. Colleges start offering relevant courses etc saving costs in training staff up for example….

The growth in mass media has meant growth in media studies courses, and better understanding among the general public.

Specialising

With growing a industry comes growing derived demand for the firms further upstream, manufacturers for example. This enables those firms to specialise wholly in their operations.

For instance a growing clothing industry will give a firm best in making buttons enough demand to reap internal economies of scale, causing specialisation.

Infrastructure Advantages

If an country has a booming industry, it will be a source of economic growth and through this the government can collect more tax revenues.

Recognising this, the government can invest in better infrastructure, transport and power facilities for instance….

With this firms will benefit from lower transport costs for materials and cheaper electricity, reducing their average costs.

External Diseconomies of Scale

Some strains of a growing industry….

Input Shortages

With booming output for an industry comes a sharp rise in demand for the relevant people and capital. Bottlenecks in factor markets can result, leading to higher average costs for all businesses.

Government Targeting

This depends on the approach a government has, more often than not they encourage their best or fastest growing industry.

We can imagine, though, that if the government has a large deficit and needs more tax revenue it may have to resort to taxing it’s largest industry, resulting in higher average costs through taxes.