Distinguish Between Internal and External Economies of Scale.

Internal economies of scale arise when firms increase their scale of production. Hence, they incur lower average costs of production, either through specialization or other factors. When average costs fall, giving the price of the good to be constant, profit margins of these firms will be increased. Thus, the individual firm benefits from internal economies of scale.

External economies of scale arise when all firms in an industry experience decreasing average costs of production, which can be due to economies of concentration, information and disintegration. Unlike internal economies of scale, external economies of scales independent on the size of the individual firms in the industry as both small and large firms benefit from it.

Secondly, internal and external economies of scale depend on several factors. Internal economies of scale arise due to technical economies, which states that as a firm increases its scale of production, it is able to delegate specific jobs to its workers. Hence, through specialization in a single job, the workers are able to improve their productivity through attaining higher levels of dexterity and skill through repeated practices. Thus when productivity per worker rises, the firm is actually producing a greater amount of goods and hence, the average cost of the good falls.

Of course, internal economies of scale also depend on other factors, such as marketing economies, which basically states that a firm making bulk purchases on raw materials would be able to enjoy cheaper prices, such as financial economies, which states that as a firm increases its scale of production and need funds to buy more factors of production, it can get it from a bank at lower interest rates. This is because its larger assets and greater selling potential provides banks with greater security. And there are also less important factors such as risk bearing and managerial economies.

External economies on the other hand, depend on mainly three