External economies of scale

Definition

External economies of scale refer to the cost advantages that a company experiences as it increases production due to factors outside the company itself. These advantages often arise from industry-wide developments, such as improvements in infrastructure, skilled labor availability, and supplier networks that benefit all firms within a specific sector or geographic area, allowing them to reduce costs and increase efficiency collectively.

5 Must Know Facts For Your Next Test

1. External economies of scale can lead to lower average costs for all firms in an industry as they benefit from shared resources and services.
2. Industries often cluster geographically to take advantage of external economies of scale, such as Silicon Valley for technology companies or Hollywood for film production.
3. Government investments in infrastructure like roads and telecommunications can create external economies of scale by lowering transportation and communication costs for businesses.
4. As industries grow and more firms enter a market, competition can drive innovation and efficiency, enhancing external economies of scale for everyone involved.
5. External economies of scale are particularly significant in industries with high fixed costs, where spreading these costs across many firms can lead to substantial savings.

Review Questions

• How do external economies of scale influence competition within an industry?
  • External economies of scale influence competition by lowering costs for all firms in an industry, which can lead to increased market entry and competition. When businesses benefit from shared resources such as infrastructure or a skilled labor pool, they can operate more efficiently and offer competitive pricing. This environment encourages innovation as firms strive to maintain their competitive edge while benefiting from the overall growth and efficiency improvements within the industry.
• Discuss the role of government policy in facilitating external economies of scale in specific industries.
  • Government policy plays a crucial role in facilitating external economies of scale by investing in infrastructure, education, and technology that support entire industries. For example, when governments improve transportation networks or provide tax incentives for research and development, they create a favorable environment that benefits all firms within an industry. Such policies can attract new businesses and encourage existing firms to expand, thus reinforcing the external benefits that come from collective growth.
• Evaluate the impact of external economies of scale on regional economic development and urban planning.
  • External economies of scale significantly impact regional economic development by fostering clusters of businesses that thrive on shared resources and infrastructure. Urban planning can be influenced by this phenomenon as cities aim to create environments conducive to business growth. By strategically investing in transport links, workforce education, and industry-specific facilities, regions can enhance their attractiveness to firms. This clustering effect not only leads to economic growth but also helps create jobs and improve living standards within the community.

Related terms

internal economies of scale:

Cost savings that result from the growth of a single company, allowing it to reduce costs per unit through efficiencies in production, management, and purchasing.

agglomeration economies: The benefits that firms experience by locating near each other, leading to reduced transportation costs, shared suppliers, and access to a skilled labor pool.

market structure: The organization of a market based on the number of firms, the nature of competition, and the level of product differentiation, which influences how economies of scale can be achieved.