Internal economies of scale are firm-specific, or caused internally, while

external economies of scale occur based on larger changes outside of the

firm. Both types result in declining marginal costs of production; yet, the net

effect is the same. External economies of scale are generally described as

having an effect on the whole industry.

Economist Alfred Marshall first differentiated between internal and external

economies of scale. Marshall suggested that broad declines in the factors of

production, such as land, labor and effective capital, represented a

positiveexternality for all firms. These externality arguments are offered in

defense of public infrastructure projects or government research.

There are several different kinds of internal economies of scale. Technical

economies are achieved from the use of large-scale capital machines or

production processes. The classic example of a technical internal economy of

scale is Henry Ford's assembly line. Another type occurs when firms purchase

in bulk and receive discounts for their large purchases, or a lower cost per unit

of input. Cuts in administrative costs can cause marginal productivity to

decline, resulting in economies of scale.

Internal economies of scale tend to offer greater competitive advantages than

external economies of scale. This is because an external economy of scale

tends to be shared among competitor firms. The invention of the automobile or

the Internet helped producers of all kinds. If borrowing costs decline across

the entire economy because the government is engaged in expansionary

monetary policy, the lower rates can be captured by multiple firms. This does

not mean any external economy of scale is a wash. Companies can still take

relatively greater or lesser advantage of external economies of scale.

Nevertheless, internal economies of scale embody a greater degree of

exclusivity

Internal and External Diseconomies of Scale

The term diseconomies of scale refer to a situation where an increase in the size of the firm leads to a rising average cost.Diseconomies of scale may be classified into internal diseconomies and external diseconomiesof scale.

The major internal diseconomies of scale arise from its size of the firm, technical causes and managerial problems. When a firm achieves a size where it is producing at the lowest possibleaverage cost it is said to be at its optimum size.The optimum size will very over time as technological progress change the technique of production. In addition to this, more loaded men and machinery leads to machine fault and human failure cause breakdown of production.  When the size increases management becomes more complex and difficult. Managerial function of co-ordination, consultation and interdepartmental decision making will get delayed due to the size. There will be possibility of delay in implementation of decision within the organization. Delay in communication will reduce the involvement of the employees. Sorting out and solving the problems of lack of identification and recognition which reduce the commitment in long run.  

 There are some external diseconomies of scale in the form of disadvantages. There is shortage of labour which causes a wage rise.  Increase in the demand for raw materials will also bid up prices. When there is heavy localization of industries, the land for expansion will become increasingly scarce.  Scarcity will cause an increase in the price to purchase land or to rent. Transport costs may also rise because of increased congestion. 

The change in output will cause a movement along the long run average cost curve. One of the most significant influences is external economies of scale.  If external economies are experienced, the long run average cost will shift down (output will be now be cheaper to produce).  Whereas external diseconomies of scale are encountered the long run average costcurve will move up (output will now be costlier to produce).  Improved technology would lower the long run average cost curve.