Diseconomies of Scale

Accountant

What are the diseconomies of scale?

Diseconomies of scale arise when a business or business grows to the point where unit costs rise. It occurs when economies of scale no longer work for a business. With this principle, rather than enduring a continuous drop in costs and an increase in production, a company sees an increase in costs when production increases.

Key points to remember

  • Diseconomies of scale occur when the expansion of production is accompanied by an increase in average unit costs.
  • Diseconomies of scale can involve internal factors in an operation or external conditions beyond the control of a company.
  • Diseconomies of scale can result from technical problems in a production process, organizational management problems or resource constraints on productive inputs.

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Diseconomies of scale

Understanding diseconomies of scale

The diagram below illustrates a diseconomics of scale. At point Q *, this enterprise produces at the point of lowest average unit cost. If the company produces more or less production, the average cost per unit will be higher. To the left of Q *, the company can take advantage of economies of scale to reduce average costs by producing more. To the right of Q *, the company is experiencing diseconomies of scale and an increase in the average unit cost.

Image of Julie Bang © Investopedia 2019

Diseconomies of scale occur specifically for several reasons, but all of them can be broadly classified as internal or external. Internal diseconomies of scale can result from technical production problems or organizational problems within the structure of a company or industry.

External diseconomies of scale may arise due to constraints imposed by the environment in which a business or industry operates. Essentially, diseconomies of scale are the result of the growing pains of a business after it has already realized the cost-saving benefits of economies of scale.

The first is an overcrowded situation, where employees and machines interfere with each other, reducing operational efficiency. The second situation arises when there is a higher level of operational waste, due to a lack of proper coordination. The third reason for diseconomies of scale occurs when there is a mismatch between the optimal level of outputs between the different operations.

Types of diseconomies of scale

Internal diseconomies of scale imply either technical constraints on the production process that the company uses, or organizational problems which increase costs or waste resources without any modification of the physical production process.

Technical diseconomies of scale

Technical diseconomies of scale imply physical limits on the handling and combination of inputs and goods in process. These may include overcrowding and shifts between the scale or the possible speed of different inputs and processes.

Diseconomies of scale can occur for a variety of reasons, but the cause usually comes from the difficulty of managing an increasingly large workforce.

An overcrowding effect within an organization is often the main cause of diseconomies of scale. This happens when a business grows too quickly, thinking that it can achieve economies of scale in perpetuity. If, for example, a company can reduce the unit cost of their product each time they add a machine to their warehouse, they might think that maximizing the number of machines is a great way to cut costs.

However, if one person is needed to operate a machine and 50 machines are added to the warehouse, there is a good chance that these 50 additional employees will interfere with each other and make it more difficult to produce the same level of production by hour. . This increases costs and decreases production.

Sometimes diseconomies of scale occur within an organization when the factory of a company cannot produce the same quantity of production as another linked factory.

For example, if a product is made up of two components, gadget A and gadget B, diseconomies of scale can occur if gadget B is produced at a slower rate than gadget A. This forces the company to slow down the production of gadget A, increasing its unit cost.

Organizational diseconomies

Organizational diseconomies can occur for many reasons, but overall, they arise due to the difficulties of managing a larger workforce. Several problems can be identified with diseconomies of scale.

First, communication becomes less effective. As a business grows, communication between different departments becomes more difficult. Employees may not have explicit instructions or expectations from management. In some cases, written communication becomes more widespread than face-to-face meetings, which can lead to fewer comments.

Another disadvantage of diseconomies of scale is motivation. Large companies can isolate employees and make them feel less valued, which can lead to lower productivity.

External diseconomies of scale

External diseconomies of scale result from economic resources or other constraints imposed on a business or industry by the external environment in which it operates. Typically, these include capacity constraints on common resources and public goods or increased input costs due to the inelastic supply of input prices.

External capacity constraints may arise when a common common resource or local public good cannot meet the demands placed on it by increased production. The congestion of public roads and other means of transportation necessary to ship a company’s output is an example of this type of diseconomics of scale.

As production increases, the logistics costs of transporting goods to distant markets may increase enough to offset economies of scale. A similar example is the depletion of a critical natural resource below its capacity to reproduce in a tragedy of the scenario of the commons. As the resource becomes scarce and eventually becomes depleted, the cost of obtaining it increases considerably.

The inelastic supply of prices for the main inputs traded in a market is a related cause of diseconomies of scale. In this case, if a company tries to increase production, it will have to buy more inputs, but the price of non-elastic inputs will mean a rapid increase in input costs out of proportion with the increase in the quantity of production produced. .

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