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INTERNAL DISECONOMIES OF SCALE AND WHY A FIRM MAY EXPERIENCE IT – REASONS FOR A RISE IN THE LONG-RUN AVERAGE COST

Updated on March 3, 2011

Rise in Long-run Average Cost

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In the long-run of production all inputs or factors of production can be varied. In other words the firm has reached that stage of production where it can increase its output by employing more of all the factors of production. It can for instance hire more labor, acquire more capital equipment, purchase more land area for expansion etc.  Enough time has elapsed for these to be possible. We say in the long-run the plant size or scale is adjusted in order to change the output level, because all inputs are variable in the long-run.

If all inputs of production of a firm are increased by some percentage and output increases by a lesser percentage, then that firm experiences decreasing returns to scale. For example, if all inputs are increased by 20% and this leads to a lesser percentage increase in output, say 15% or anything less than 20%, then that firm experiences decreasing returns to scale.

WHY A FIRM MAY EXPERIENCE DECREASING RETURNS TO SCALE

When a firm expands its production scale beyond a certain level, it suffers certain disadvantages. These disadvantages are called internal diseconomies of scale. The result of this diseconomies of scale is a fall in output and increase in the long-run average cost. There are a number of factors that might give rise to inefficiencies as the size of the firm grows.

As the size of the firm grows beyond a certain level, organization, control and planning is needed. This makes the administrative duties more difficult. Delegation of much of the management functions to lower personnel becomes very common. Since these personnel lack the requisite experience to undertake the task, it may result in low output at higher cost. Again it is often difficult to arrive at quick decisions since large firm often have many directors and departmental heads, through whom suggestions must pass before they are implemented. All these lead to an increase in the long-run average cost.

As the firm increases in size, management-employee relation becomes impersonal. This means supervision would be relaxed. Labor may resort to lateness and absenteeism. In short, workers work less efficiently.

The increase in the size of the firm may lead to labor diseconomies. Workers become so crowded that space needed for each worker to work efficiently becomes minimal. Over-specialization and division of labor creates over-dependence. This situation can be detrimental to the firm if one worker should be absent. All these cause an increase in the long-run average cost of production.

Advertising expenses may increase, as the problem of distribution and marketing increases due to an increase in the size of the firm.

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