Internal economies are economic advantages, which enable a firm to get proportionately large output than increments in factor inputs, thus, causing increasing returns to scale. These economies are peculiar to each firm. They depend solely upon the size of the firm and are different for different firms.
Some of the internal economies are as follows:
(a) Specialisation and Division of Labour:
As scale of production expands, higher degree of specialisation and division of labour becomes possible. Under division of work, production of a commodity is spilt up into several processes. Each worker specialises in one particular process.
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As the worker performs the same operation again and again, the skill and dexterity of each worker is improved. Mass production methods like the assembly line in the motor car industry are available only, when the level of output is very large.
They are more efficient than the best available processes for producing small levels of output. Specialisation and division of labour increases the proficiency and perfection of the labour and reduces wastage of time in moving from one job to the other and also in changing tools. This results in higher productivity, causing increasing returns to scale. Labour cost per unit of output decreases as a result.
(b) Technical Economies:
The technical economies arise from the greater efficiency of large size of plants and capital equipments, which the large firms can afford to employ, but not small ones. It is possible to take full advantage of division of labour and specialisation.
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Superior more specialised and automatic machines can be installed by them. Though, fixed cost of the machinery may be very high, but, the average cost will be much lower as the total cost will be spread out over a large volume of output.
Thus, the large firm enjoys the economy of superior technique. Similarly, the use of computer is economical only for large undertakings. It can have an independent research and development unit for further improvement and perfection in technology. Moreover, most of the factors, particularly man and machinery are indivisible.
Full use of them can be made only, when production is carried on a large scale. At a small scale of production, they remain underutilised. Therefore, when scale of production is increased by increasing all inputs, productivity of indivisible factors increases considerably and thus results in increasing returns to scale.
Further, there is mechanical advantage in using large machines and other mechanical units. Large units are not only cheaper to operate (running cost) but also cheaper to construct (initial cost). It is called economy of increased dimensions. An example given by Donald Watson for better space utilisation is worth nothing.
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“A wooden box that is 3-foot cube can contain 27 times as much as a box that is a 1-foot cube, but only 9 times as much wood is needed to the larger box”. Tanks, blast furnaces, connecting pipes, and other static as well as mobile containers are examples of this type of economy.
(c) Production Economies:
The large firm is able to utilise all its waste materials for the development of by-product industry. Thus, it enjoys the economy of the use of byproducts. For example, the baggasse left over after manufacturing sugar from the sugarcane can be used for producing paper by installing a plant for this purpose.
Further, molasses can be used to produce spirits. It can also reduce its cost by linking various processes of production. A large firm can enjoy the benefit from backward as well as forward integration of processes. The firm can avoid purchase of raw materials and other inputs from outside suppliers (for obtaining packaging materials like boxes, labels, etc.) by manufacturing these inputs itself.
This forward integration would reduce the dependence of the firm on others and help the firm to produce the inputs according to its own requirements. It can also itself employ technicians for repairing the machines, reducing dependence on others.
Similarly, by directly selling the product to the final consumers, the firm, on one hand, saves the expenses on intermediaries. On the other hand, it can gather correct information about the market conditions. This is a case of forward integration.
Further, a firm operating at a large scale can also have reserve capacity in their plants, machinery and other equipments. Such firm is in a better position to meet changes in demand conditions, avoid disruption of production in case of breakdown of machinery, etc.
Furthermore, a large firm can maintain the inventory of spare parts to replace worn out or damaged parts of the equipment. It can also maintain adequate inventory of inputs and finished commodities to meet unanticipated rise in demand.
Finally, a big firm can well afford to introduce systems like inventory control in the stores procurement division to avoid excessive procurement of raw material leading to blockage of capital. This system also avoids shortage of essential materials.
(d) Managerial Economies:
These economies arise due to better and more elaborate management, which only the large firm can afford. In a large firm, the owner can concentrate on fundamental problems of policy-making and business expansion, delegating the routine jobs and details to highly qualified subordinates.
Besides, he can also engage specialised staff and managers to look after production, accounts, sales, planning, personnel, advertisement, etc. He can, thus, secure the advantages of functional specialisation. Further, managerial cost is reduced, when the scale of production increases.
The extent to which managerial economies can be enjoyed depends on the efficiency of the manager. Computer network, telex machines, fax machines, electronic mail services may be used for this purpose to save time, money and effort.
(e) Marketing Economies:
As the firm expands in its size, it is able to buy raw materials at cheaper rates as it buys regularly and in bulk quantities. It can secure concessions from railways and transport companies. It also enjoys prompt delivery, careful attention and considerate treatment from all intermediaries. It can even have its own transportation and distribution system, which avoids uncertainties, irregularities and difficulties from raw material stage to the final finished product stage.
The large firm generally has a separate marketing department manned by experts, who keep records of market trends correctly. They buy and sell on behalf of the firm in favourable market conditions. Thus, a large firm cuts down its selling cost.
It has a wider choice in purchasing too. In this way, marketing economies are reaped by the big firm in its promotional activities involving selling, sales promotion, advertising, etc. and distributional activities including logistics management, dealing with order handling, storage, transportation, etc.
Large firms are also able to undertake extensive market research to identify the needs and changing preferences of the consumers so as to modify the attributes and features of the existing products or develop new products accordingly.
In house research and development department with trained research staff may be created for this purpose. This department may do in house innovations and inventions in production process and in the product itself for appreciable increase in production and sales.
(f) Financial Economies:
The large firm with a large asset base and goodwill in the market is able to secure the necessary funds either as block capital or for meeting the working capital needs of the enterprise. It can float debentures and get them subscribed by the public. It can borrow from the banks and other financial institutions at relatively cheaper rates. Such opportunities are not available to small firms.
(g) Risk and Survival Economies:
Every firm has to face general and particular risks for its existence. While former occur during general business depression due to insufficient demand, latter refer to market fluctuations for a product. Small firms cannot survive in the face of such risks and go into liquidation.
Large firms, on the other hand, not only absorb such shocks (both minor and major), but also diversify their output, sources of supply, market and processes of manufacture. A large firm can withstand the risk of changing consumer’s tastes and preferences.
(h) Economies of Employee Welfare Schemes:
A large firm with adequate resources can provide employee welfare facilities for its managerial and technical staff, both within and outside the factory. Free or subsidised lunch, uniform, recreation rooms, creches for the children of the working women, provision of housing, medical and educational facilities for employees and their families also improve the working conditions of the employees.
These measures enhance the motivation, morale and commitment of the employees to the firm and its objectives. All this raises the efficiency of the human capital and hence production.