What are external economies of scale?

Economies of scale occur when companies can reduce their costs per unit of production of goods or services by increasing output. When the factors that create these situations occur outside the business itself, they are considered external economies of scale. For example, an improved transportation system in a country can allow companies to ship more goods at a lower unit cost. It is considered external if the companies did not participate in the improvement of the transport network. Such situations usually occur because an industry is growing in size, which allows companies in that industry to benefit and achieve lower costs per unit of goods or services.

One of the first great external economies of scale with far-reaching results was the invention of the automobile. Before cars, trucks and trailers, goods were transported from one place to another by rail, which meant that industries dependent on the goods had to be located close to a train station. This influenced the cost of real estate and increased overhead and production costs. With the introduction of the automobile, companies could operate anywhere in the city, which reduced the costs of transporting goods over short distances, as it was cheaper to ship these goods by car than by train. Low shipping costs often meant less cost to produce items.

When an industry expands, companies in that industry often benefit from external economies of scale. For example, high-tech companies can benefit from factors resulting from a booming high-tech industry, such as a government improving communications networks or colleges and universities producing more skilled workers to meet industry demands. These companies can also benefit from a booming industry because the number of suppliers can increase, creating competition and lowering supplier prices.

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