Industry growth can change a firm's costs even at unchanged scale.
External economies of scale are cost advantages a firm obtains from growth or development of the industry rather than its own expansion. An industry cluster may support specialist suppliers, shared training or infrastructure that lowers firms' long-run average cost. External diseconomies can arise when industry growth congests roads or competes for scarce inputs. A firm can be affected while keeping its own scale unchanged. Show a change in its cost conditions, such as a downward or upward LRAC shift, and explain the mechanism rather than treating any nearby business as a benefit.
- External economy
- External economies of scale come from growth or development of the industry, rather than this firm's expansion. Shared services or specialist suppliers can lower its long-run cost per unit.
- External diseconomy
- External diseconomies occur when industry growth raises firms' unit costs, for example through congested deliveries or competition for scarce workers and premises.
- Own scale
- The firm can keep the same output and plant while industry changes affect its costs. Its LRAC curve shifts down with a saving or up with an added cost.
Apply the distinction
Diagram
Represent changed long-run cost conditions by an LRAC shift at given output, rather than just a movement along the old curve.
Net effect
Supplier savings can coexist with congestion or scarce-input costs; compare their importance.
Worked example: A shared maintenance service
A food-processing cluster, a group of related businesses in one area, becomes large enough to support a specialist maintenance service. A small processor keeps the same output, plant and quality but can obtain the same maintenance more cheaply. Later, traffic congestion in the cluster increases delivery time and cost.
- The maintenance saving comes from an industry-supported service, not the processor becoming larger itself. It can lower its unit costs at a given scale.
- That is an external economy of scale under the stated industry-growth mechanism, represented by a lower LRAC schedule for the affected firm.
- Congestion works in the opposite direction: more industry activity can increase relevant unit costs and shift LRAC up.
- The net result depends on savings and extra costs. Shared facilities also charge fees, so their existence alone does not prove each user's net cost falls.
Watch out for this
External economies mean a firm moves down its own LRAC simply by making more output.
That describes an internal scale comparison. External economies change cost conditions through industry development.
Check your understanding
A firm keeps its scale unchanged but industry congestion raises transport cost per unit. Which description fits?
- Internal economy of scale.
- A demand increase.
- External diseconomy of scale.