DEFINITION of External Diseconomies of Scale
External diseconomies of scale are the result of outside factors beyond the control of a company increasing its total costs, as output in the rest of the industry increases. The increase in costs can be associated with market prices increasing for some or all of the factors of production.
BREAKING DOWN External Diseconomies of Scale
Factors of production are the inputs that firms use in order to produce output. The inputs include land, labor and capital. Some economists include entrepreneurship as well.
For example, there might be a manufacturer of "widgets" operating in a given city. If the average wage level increases across all other markets as a result of an increased demand for labor, the manufacturer must pay higher wages to entice workers to produce those "widgets." These factors would raise the total costs for the manufacturer.
Causes Behind External Economies of Scale
The introduction of additional competitive rivals in a given industry is sometimes pointed to as a key factor in external diseconomies of scale. As more companies compete for the same workforce, the salaries each company offers may need to increase in order to attract the needed personnel.
This differs from internal influences such as the size of the company. It is possible that a business could grow so large that it must raise prices to accommodate its elevated infrastructure and logistics costs.
Certain industries that rely on access to materials that become more difficult to come by may face external diseconomies of scale. For instance, as more and more fossil fuels are expended, petroleum companies may be forced to search for this resource in harder to reach locations. This can include drilling deeper and deeper underground and exploring the use of alternative fuel sources, all of which can require a considerable outlay of financing. That can include additional work hours, more equipment, and dealing with securing access to new areas where oil may be found. The harder it becomes to find this resource, the higher the costs will rise in order to tap into it.
An industry-wide change in primary materials used in the production of goods and services can also lead to such diseconomies of scale. The electronics industry, for example, adopted new formats and components with the introduction of flat screen, high definition televisions. The move away from cathode ray tube hardware meant establishing new manufacturing techniques in order to remain competitive. Prices for the first flat screen, high-definition televisions were higher than their dated counterparts not only because the older technology was being rendered obsolete. The time and cost to produce these new models carried higher expenses that the product makers were compelled to pass along to their customers.