What is 'External Economies Of Scale'

External economies of scale imply that as the size of an industry grows larger or more clustered, the average costs of doing business within the industry fall. This may occur due to increased specialization or labor training, faster innovation or shared supplier relationships. These are generally referred to as positive externalities; industry-level negative externalities are called external diseconomies.

BREAKING DOWN 'External Economies Of Scale'

External economies of scale also refer to how an industry might experience a downward-sloping supply curve, at least within a given range. Economies of scale, whether external or internal, refer to factors that drive down average production costs as output volume increases. However, there is a limit to the realizable economies of scale based on any given factor. This occurs whenever the added costs of complexity associated with a larger output volume exceed the benefits of greater scaling.

Industry Level Scaling

Unlike internal economies of scale, which occur at the firm level, an external economy of scale manifests at an industry-wide level. The key characteristic of external economies is individual firms have no direct control over their development, which means they cannot exclude competitors from benefiting as well. British economist Alfred Marshall is frequently credited with distinguishing between external and internal economies of scale.

There are many reasons such scaling may occur. For example, one firm might determine that California is a particularly good location for year-round film-making. More firms decide to move operations to California to take advantage of the specialized labor and infrastructure already in place thanks to the success of the first firm. As more and more firms succeed in the same area, new entrants can take advantage of even more localized benefits.

This is one reason businesses in the same industry tend to cluster in specific regions. It makes sense for new movie producers to locate to Hollywood, since there are more camera operators, actors and actresses, costume designers and screenwriters in the area. Successive firms are able to realize more cost advantages in such areas.

Across Industries Scaling

If two or more separate industries are incidentally beneficial to one another, there can be external economies of scale across the entire group. This is sometimes called "agglomeration economies" and is very similar to the business governance concept of synergy.

Concepts such as external economies of scale or agglomeration economies may help explain why growth does not spread evenly across a country or set of countries. They may also explain why urban areas are able to grow fast enough to support larger and larger populations. Major innovations, such as the automobile or the internet, result in wide-spread agglomeration benefits.

  1. Externality

    A consequence of an economic activity that is experienced by ...
  2. Production Externality

    Costs of production that must ultimately be paid by someone other ...
  3. External Diseconomies Of Scale

    External factors beyond the control of a company increases its ...
  4. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased ...
  5. Pigovian Tax

    A special tax that is often levied on companies that pollute ...
  6. Break

    A term used in futures markets to describe a rapid and sharp ...
Related Articles
  1. Small Business

    What Are The Differences Between Internal And External Economies Of Scale?

    Internal economies of scale are firm specific. External economies of scale occur due to large changes outside of a firm that usually impact an entire industry.
  2. Insights

    What Are Economies Of Scale?

    Is bigger always better? Read up on the important and often misunderstood concept of economies of scale.
  3. Small Business

    Understanding Externality

    An externality is a consequence of an economic activity that is experienced by unrelated third parties.
  4. Insights

    Explaining Minimum Efficient Scale

    Minimum efficient scale is the smallest amount of production a firm can achieve while still taking full advantage of economies of scale.
  5. Managing Wealth

    Is Pressing The Trade Just Pressing Your Luck?

    Scaling up into a trade can be a lucrative strategy, but you need to understand the risks involved.
  6. Insights

    Sovereign Debt Overview

    The national or government debt is a combination of both internal and external debt. The external debt is referred to as Sovereign Debt. Sovereign Debt refers to bonds issued by a nation’s ...
  7. Insights

    Understanding Diseconomies of Scale

    Diseconomies of scale is the point where a business no longer experiences decreasing costs per unit of output.
  8. Trading

    Effective Risk Control With Scaling Trading Strategies

    Scaling strategies allow for greater risk control than simple entries or exits, letting traders seek the most advantageous prices available.
  9. Investing

    Which Countries Will Drive Global Growth in 2016?

    Given the volatility that has already shaken the global economy, the world's largest economies will be leaned on to stimulate growth in 2016
  1. What are the differences between internal and external economies of scale?

    Take a deeper look at the differences between internal and external economies of scale, and learn why internal economies ... Read Answer >>
  2. What are some examples of economies of scale?

    Take a look at different examples of economies of scale, including how marginal costs can be reduced through external and ... Read Answer >>
  3. What is the difference between external economies and external diseconomies?

    Learn to differentiate between external economies and external diseconomies, as well as between external economies and diseconomies ... Read Answer >>
  4. How do I decide whether a credit card offer is a good deal or not?

    Discover the ways that externalities lead to market failure. Externalities are costs or benefits that go to a third party, ... Read Answer >>
  5. How can companies reduce internal and external business risk?

    Understand the difference between internal business risk and external business risk. Learn how a company can reduce each ... Read Answer >>
  6. How do economists measure positive and negative externalities?

    Learn the definition of positive and negative externalities and which methods economists use to measure externalities in ... Read Answer >>
Hot Definitions
  1. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  2. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  3. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  4. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  5. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  6. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
Trading Center