Production and Operations Management

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External economies of scale

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Production and Operations Management

Definition

External economies of scale occur when a company's production costs decrease due to external factors, such as industry growth or improvements in infrastructure, rather than changes within the company itself. These benefits arise from the overall expansion of the industry or improvements in the environment surrounding a business, leading to enhanced productivity and efficiency for all firms involved.

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5 Must Know Facts For Your Next Test

  1. External economies of scale benefit all companies in an industry, not just the individual firms that may be expanding or improving.
  2. These economies can result from factors such as improved transportation networks, access to skilled labor pools, or better supply chain services.
  3. Regions that experience external economies often become hubs for specific industries, attracting more businesses and talent, further driving down costs.
  4. External economies can enhance competition by allowing smaller firms to thrive alongside larger ones due to shared resources and lowered barriers to entry.
  5. Examples include Silicon Valley for tech companies or Hollywood for film production, where a concentration of related businesses creates an ecosystem that fosters growth.

Review Questions

  • How do external economies of scale differ from internal economies of scale in terms of their impact on individual firms?
    • External economies of scale differ from internal economies because they arise from factors outside a single company, benefiting all firms within an industry. While internal economies are related to a firm’s own production processes improving efficiency as it grows, external economies enhance the entire industry's productivity through shared resources or improved infrastructure. This means that external economies can help even smaller firms compete more effectively against larger companies by lowering costs for everyone.
  • Discuss how agglomeration can lead to external economies of scale and provide examples of industries where this is evident.
    • Agglomeration leads to external economies of scale by concentrating related businesses in one area, allowing them to share resources such as suppliers, labor, and information. This clustering can reduce costs and improve innovation. For instance, Silicon Valley is an example where tech companies benefit from being close to each other, sharing talent and ideas, while Hollywood serves as an example in the film industry where studios, talent agencies, and production facilities are located near one another.
  • Evaluate the long-term implications of external economies of scale on industry competitiveness and innovation.
    • The long-term implications of external economies of scale on industry competitiveness and innovation are significant. As industries benefit from reduced costs and shared resources, they can become more competitive both domestically and globally. This competitive edge fosters continuous innovation as companies strive to improve their offerings and efficiencies. Furthermore, as new firms enter the market due to lower barriers created by these economies, the overall landscape becomes dynamic and encourages advancements in technology and practices that push the industry forward.
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