Theory of the Firm 4

v) Technical economies:

These are benefits that accrue to a firm from the use of specialized labour and machinery.

Large firms have access to large capital which they utilize to obtain those machines and hire the specialized labour.

The machines use the latest technology and are put to full use, making the firm production more
efficient i.e. cost of the machines and labour are spread over many units of output hence less costly but giving higher profits.

vi) Research economies:

Large firms can afford to carry out research into better methods of production and marketing.

(Research is necessary because of the increased competition in the business world today)

This improves the quality of the products and
increases the sales and profits made by the firm.

vii) Staff welfare economies:

Large firms can easily provide social amenities to their employees including recreations, housing, education, canteens and wide range of allowances.

These amenities work as incentives to boost the morale of the employees to work harder and increase the quality and quantity of output. This leads to higher sales and profits.

viii) Inventory economies

A large sized firm can establish warehouses to stock raw materials and therefore enjoy large stocks of raw materials for use when the raw materials are in short supply.

Thus, the firm can avoid production stoppages that can be occasioned by shortages of the raw materials.

The suppliers of such material may be sold at a higher price to realize profit.

External economies of scale:

External economies of scale are those benefits which accrue to a firm as a result of growth of the whole industry. They are realized by a firm due to its location near other firms. They include;

a) Easier access to labour:

Where many firms are located in one area a
pool of labour of various skills is usually available.
Therefore firms relocating to the area find it easy to obtain.

b) Improved/efficient infrastructure:

Usually where many firms are located, infrastructure would be highly developed e.g. roads, power, water and communication facilities. Firms relocating in that area thus enjoy the services of infrastructure already in place.

c) Firms may be able to dispose off their waste product easily.

d) Ready market may be available from the surrounding firms.

e) Readily available services such as banking, insurance and medical care.

f) Adequate supply of power due to large volume of consumption e.t.c.

Diseconomies of scale

A firm cannot continue to expand indefinitely or without a limit.As a firm grows or industry expands, the benefits the firm can reap or get from such growth or expansion have a limit.

Any further expansion in the scale of production beyond the limit will actually create negative which would increase the cost of production.

The negative effects to a firm due to its size or scale of production are referred to as diseconomies of scale.

Diseconomies of scale are therefore the problems a firm experiences due to expansion.

Sources of diseconomies of scale

Diseconomies of scale may arise from:

a) Managerial functions which become increasingly difficult to perform as the firm expands. Communication and consultations take more time than before.

b) Changing consumer tastes which may not be fulfilled immediately because decision-making may take too long.

c) Increase in the costs of transporting raw materials, components and finished products.

d) Labour unrest or disputes and lack of commitment from the employees because they are not involved in decision making.

e) Stoppage of production process when disputes arise since all production stages are interdependent and labour specialized.

f) Lack of adequate finances for further expansion of the firm.

[There are two forms of diseconomies of scale fiz internal diseconomies and external diseconomies of scale.

Internal diseconomies of scale

These are the problems a firm experiences as a result of large scale production
due to its persistent growth.

They include;

i) Managerial diseconomies of scale

These are the losses which may arise due to the failure of management to supervise and control the operations properly.

This may be because the firm is large resulting into;

a) Difficulties in controlling and coordinating the departments leading to laxity among employees.

b) Difficult in decision making and communication and co-ordination between management and workers.

Delays in decision
making means lost opportunities.

c) Impersonal relationship between management and workers, and staff problems not easily established which could lead to low morale,
disputes, unrests/skills.

d) An increase in management tasks leading to increase in number and impact of risks i.e. any error in judgement on the part of management
may lead to big losses.

ii) Marketing diseconomies of scale

These are losses which may arise due to changes in consumer tastes. These may be as a result of;

a) A change in tastes leading to fall in demand for the firms products.

A large firm may find it difficult to immediately adjust to the changes in the tastes of consumers, hence it will experience fall in its scale.

b) An increase in the scale of production, which leads to higher demand for factor of production such as labour, raw materials and capital.

This will result into higher prices for them. This will push up the prices of the
goods and services produced, which will cause a fall in sales.

iii) High overhead costs

When the output of a firm increases beyond a certain limit, some factors may set in to increase the average costs.e.g the overhead costs incurred in production and marketing activities may increase.

This is because firms may intensify their promotional campaign, incur heavy transport expenses and be forced to offer generous discounts in an effort to attract more

All these are factors that may increase overheads without any corresponding increase in real benefits to the firm.

iv) Financial diseconomies of scale

These are losses which may arise due to a firm’s inability to acquire adequate finances for its expansion. This will prevent the firm from
expanding further thereby limiting its capacity to increase the volume of its output.

External diseconomies of scale

These are demerits that affirm experiences as a result of growth of the entire industry.

These include;

- scramble for raw materials

- unavailability of land for expansion

- scramble for available labour

- competition for available market

- easy targets especially in times of war

Existence of small firms in an economy.As the firm grows in size, its scale of production increases.However, many firms remain small even though they face stiff competition from larger firms.

Some of the reasons for existence of small scale firms include;

a) Size of the market

Large-scale production can only be sustained by a high demand for a product.

If the demand for a product is low, it may not be advisable for a firm to produce on a large scale, hence it will remain small.

b) Nature of the product;

The nature of the product sometimes makes it impossible to produce in large quantities e.g. personal services e.g. hairdressing, painting or nursing can provided by an individual or a small firm.

c) Simplicity of organization

Small firms have the considerable advantage of simplicity in organization.

They avoid bureaucracy, wastage and managerial complexity associated with large scale organizations.

Where a firm intends to take advantage of simplicity, the proprietor may maintain its small firm.

d) Flexibility of small firms

Small firms are flexible i.e. one can easily switch from one business to another where an owner of a business wishes to maintain flexibility so as to take advantage of any new opportunity, he/she may have to maintain a small

e) Quick decision making

In a situation where proprietors want to avoid delay in decision-making, they may opt to maintain a small business as this would involve less consultation.

f) Belief that a small firm is more manageable

Many small businesses have the potential of expansion, yet their owners prefer to have them remain small believing that big businesses are difficult to run.

g) Rising costs of production

In situations where production costs rise too fast, such that diseconomies of scale set is very early, the firm has to remain small.

h) Need to retain control

In order to retain control and independence, the owners of the firm may wish to keep it small.

Theory of the Firm 1 | Theory of the Firm 2 |
Theory of the Firm 3 | Theory of the Firm 4 |
Theory of the Firm 5 | Theory of the Firm 6 |

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