Internal economies accrue to individual firm. Each firm can effect reduction in its cost of production by expanding, its scale of production to the optimum point.
Expansion in the scale of production makes it possible for the firm to make better use of the hitherto underutilized resources.
At the same time the large scale of production makes it convenient for the firm to introduce better division of labour.
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In the words of Stonier and Hague, “These are those economies in production-those reductions in the production costs- which can be carried within the firm itself when output increases.” These economies are particular to the individual firms. They do not reach the whole of industry.
There are mainly two factors that give rise to internal economies. They are as follows:
(i) Indivisibilities, and
(ii) Specialization
(i) Indivisibilities:
There are certain factors of production that cannot be used in parts. For example, operating cost of a 747 Jumbo jet will be the same irrespective of the number of passengers on board that may vary from zero to 350.
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Likewise a manager cannot be chopped in half and asked to produce 500 units of the commodity instead of 1,000 units.
Apparently, cost of manager per unit of output shall be less if 1000 units are produced instead of 500 units.
Similarly, a plant equipped to produce 1,000 scooters per month shall work at its maximum efficiency if it produces at its full capacity.
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Otherwise, the plant would turnout scooters at higher per unit cost, since its expenses on depreciation, cost towards maintenance of plant, rent of the buildings and the other factors contracted for employment shall remain the same whatever be the level of production.
Larger scale of production makes it possible to make better use of the indivisible factors of production.
At small scale of production, factors remain unutilized without any corresponding advantage to the producer in terms of the expenses or the costs to be increased on those factors. Thus large scale production brings in economies of scale.
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(ii) Specialization:
Large scale production makes it possible to introduce better division of labour. Through division of labour it is possible for a firm to have more units of output at a lesser average cost, that is to reap economies of scale.
Benefits or economies are reaped when a worker is given to do the same job again and again. It is a well known fact that practice makes a man perfect.
A worker well versed in his special work will be responsible for more output. Thus, in the much celebrated Adam Smith’s pin industry, every individual labourer engaged in producing whole of a pin by himself shall end up with a few dozen pins at the end of day’s labour.
But if the same individual works as a link in the whole process of manufacturing pins, it is possible (a) to save on time involved in shifting from one process to another and (b) to take advantages of the specialization and perfection reached by the individual at a particular process.