Internal economies of scale are reductions in average cost resulting from the growth of the individual business. External economies of scale are reductions in average cost caused by the growth of the industry or improvements in the business's location.
This is SL and HL content from Subtopic 1.5: Growth and evolution.
How the Difference Works
An economy of scale occurs when increasing the scale of operations lowers the average cost per unit. The key distinction is whether the source of the cost reduction is controlled by the business itself or occurs outside it.
| Internal economies of scale | External economies of scale |
|---|---|
| Arise from the growth of one business | Arise from the growth of an industry or business region |
| Usually available only to the growing business | Potentially available to all businesses in that industry or location |
| Examples include purchasing, technical, managerial, marketing and financial economies | Examples include specialist suppliers, improved infrastructure, a skilled labour pool and shared industry knowledge |
For example, a supermarket chain may negotiate a lower price per product because it purchases in bulk. This is a purchasing economy of scale and is internal because the saving results from that supermarket's own size.
By contrast, if many technology businesses establish operations in one city, specialist training providers and component suppliers may move there. Every local technology business could then benefit from better recruitment and lower supply costs. This is external because the cost advantage results from growth outside any single business.
A common misconception is that external economies come from a business expanding internationally. This is incorrect: “external” refers to factors outside the individual business, not necessarily outside its country.
Exam Technique
For an explain question at AO2, identify the source of the cost reduction and develop the causal chain: growth leads to a specific advantage, which lowers average cost per unit. Apply the point directly to the organization in the stimulus rather than merely listing examples.
