It depends on the individual entrepreneur, how far he is able to take advantage of these economies. To the extent he is able to make use of them he will be able to reduce the cost of production. This is called as internalisation of external economies.
In short, in the words of Stonier and Hague, “external economies are those economies in production which depend on increases in the output of the whole industry rather than on increases in the output of the individual firm. External economies occur where an increase in the size of an industry leads to lower costs for each individual firm comprising the industry”.
Some of the examples of external economies are:
(i) The availability of better transportation and communication facilities at cheaper rates with the expansion in the volume of traffic (freight).
(ii) When in an area, a number of firms producing the same commodity are set up, a number of other firms will be established to make adequate and certain supply of raw materials, accessories and parts to earlier group of firms at reasonable prices. Even specilised firm are set up to make use of by products.
(iii) Opening of net work of transportation, communication, banking system, insurance companies, warehouses and other commercial services.
(iv) Development of specialised marketing agencies and facilities of joint publicity.
(v) Provision of better and more adequate sources of power, water and electricity.
(vi) Establishment of technical and engineering institutions ensuring continuous supply of skilled manpower.
(vii) Better housing, public health and recreational facilities.
(viii) Growth and development of ancillary industries, making use of waste matter by giving it the shape of by-products.
(ix) Availability of unskilled workers and technical personnel’s and skilled workers.
(x) Setting up of Government agencies to facilitate permits, licenses and other clearances.
(xi) Interacting with other concerns in research and development by pooling manpower and financial resources and protecting the mutual interests of all to improve the production process and reduce cost of production.
(xii) Appearance of trade journals simulates inventions and improvements in technical knowledge through supply of information as to availability of new source of raw materials, export and import potentialities, and change in Government’s policy affecting the industry as a whole. This information provides competitive edge to all the firms vis-a-vis foreign competitors.
External economies arise mainly due to localisation of industries and specialisation. Localisation of industry means concentration of a number of firms producing the similar products at a place.
This may be due to natural advantages or acquired advantages that the place has for the production of a particular commodity. Further, concentration of firms in an area induces the emergence of firms supplying the specialised services such as advertising agencies, legal consultation, accountancy, distributionship, etc. Provision of these common services leads to reduction in costs.
External economies operate up to the point of optimum capacity. Beyond this point economies give place to diseconomies. The same forces which were working to the advantage of the firms start working against them. Some of the external diseconomies are:
(i) Intense competition among the firms raises the price of the raw materials and the factors of production.
(ii) Concentration of firms in an area puts heavy pressure on the transport system causing frequent traffic jams and severe bottlenecks. Accordingly, delays take place in transporting raw materials and finished products.
(iii) The congestion in an area necessitates heavy expenditure on housing, worker’s welfare, amenities, and health and pollution control.
(iv) Scarcity of fuel, electricity, water, power, finance and technical labour raises the price.
(v) Management and coordination becomes difficult.
(vi) Pressure on banks and financial institutions causes financial problems for the firms.
(vii) Exhaustibility of non-renewable natural resources like coal raises the cost of production.
Both internal and external economies arise with the expansion of the scale of production. But, the distinction between internal and external economies is to be noted. While the former are particular to an individual firm, the latter are shared by all the firms in an industry together. Thus, internal economies depend upon the size of individual firms, while external economies depend on the growth of an industry and localisation of the industry in a particular area.
Distinction between internal and external economies is not water light. There can be instances in which external economies enjoyed by the firms may become internal economies to some other firms or industry.
For example, the development of electricity in a region will confer external economies to all the firms in the industry using electricity, while improvements introduced by individual firms will be of the nature of internal economies.
Similarly, expansion in production capacity of steel industry will bring internal economies to the steel producers. Consequently, availability of cheaper steel to other firms, using steel as raw material, shall imply reductions in their cost of production.
These reductions in costs are in the form of external economies. Robertson visualises such situation as internal- external economies. In brief, internal and external economies are closely related and are interdependent on each other.