When a firm continues to expand beyond the optimum capacity, economies of scale will disappear and will give place to diseconomies. A given percentage increase in all the factors will be followed by less than a proportionate increase in the total output. Average and marginal product will diminish as a result.
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Thus, diseconomies are the disadvantages which a firm faces by expanding the scale of production beyond the point of optimal capacity. As these diseconomies are peculiar to a firm, they are also called internal diseconomies; some of the diseconomies of scale are as follows.
(a) Inefficiency of Management:
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Management involves planning, organising, controlling and coordinating a wide variety of activities like production, sales, advertisement, transportation, etc. When output exceeds the optimum level, management problems increase and managerial efficiency declines. Problem of coordination and control of various activities emerges.
Further, with increase in the number of levels of managerial hierarchy, over loaded top management is forced to delegate responsibility and authority to lower management to avoid delay, red tapism, etc. But, the lower level officials may not have the necessary knowledge and experience to take decisions.
Furthermore, the persons who manage the firms and who take the final decisions are far removed from the actual level of operations. They are forced to take decision on the basis of twisted, limited and distorted information (second hand information). Long chain of command often causes delay in taking decisions.
Increase in the span of control makes the supervision and control over the subordinate’s activities difficult. Besides, loss of personal contact between management and workers results in labour troubles.
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Finally, an increase in the size of the firm leads to loss of initiative, morale and motivation on the part of persons at lower levels. Thus, if all the factors are increased in a given proportion, total output does not increase by the same proportion due to increased complexities of management and consequent higher management costs causing diminishing returns to scale.
(b) Technical Diseconomies:
Every equipment has an optimum capacity at which it works most efficiently and economically. If production is increased beyond the optimum point, diseconomies arise. This will happen mainly, because, indivisible factors are being used to produce too much output. They are in less than optimum proportions with the variable factors.
Further, high cost of maintenance and heavy losses in case of a breakdown or any accident may come in the way of going on for superior technology. Lack of availability of technical experts to handle the superior machines is still another restraining factor.
(c) Financial Diseconomies:
In view of the public policy and control over monopolies and concentration of wealth and income, the Government, banks and the financial institutions are granting various concessions to small firms. On the other hand, numbers of curbs are being imposed on the large borrowers, which serve as restrain on large scale production.
(d) Risk and Survival Diseconomies:
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Top management may become reluctant to expand further by borrowing capital for fear of losing control. The commitment to make interest payments on borrowed funds acts as damper to expand by borrowing.
Large firms are more exposed to the risks than the smaller ones due to the lack of liquidity. Even risks like strike, lock out, lay off are more in case of large establishments. An error in decision making by the top management may adversely affect the performance of the firm, resulting in losses.
(e) Limited Availability of Natural and Human Resources:
Limited availability of natural resources also causes diminishing returns to scale. For example, doubling of coal mining plants will not double the coal output due to limited availability of coal deposits. With expansion in the scale of production, workers may have to be recruited from other regions by offering them higher wages.