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Diseconomy

An increase in long-run average costs of production which comes about when the scale of production is increased. There is an important distinction between (a) internal diseconomies and (b) external diseconomies. Internal diseconomies arise as the result of the expansion of the indi­vidual firm. Their main source is the possibility of increased administrative costs per unit of output, which in turn is a result of increased problems of coordinating activities on a greater scale, a lengthening of the management hierarchy and a growth of bureaucracy. Though logically we expect that there must be scales of output at which such diseconomies occur, in practice it appears that large firms may be capable of avoiding them by specialization in administrative functions, introducing electronic equipment such as computers, and delegating authority and responsibility to avoid delays and bottlenecks. External diseconomies arise as a result of the expansion of a group of firms, this expansion creating cost increases to one or more of them. Such diseconomies are usually classified into:

(a) Pecuniary: these are diseconomies arising from increases in prices of inputs caused by expansion in demand of firms which use them, e.g. expansion of the oil-refining industry may cause the price of crude oil to rise, thus creating an external pecuniary diseconomy to any one firm buying crude oil (it is assumed that expansion by that firm alone . would not have caused a rise in prices).

(b) Technological: these are diseconomies arising out of higher input requirements per unit of output. For example: as firms in particular areas expand, road congestion increases due to increased deliveries, shipments, etc., and this increases the transport costs of all firms; similarly, expansion of a group of chemicals firms located along a river bank may lead to increased discharge of effluent .into the river, thus increasing costs of cleaning and using the water to firms located downstream.

Reference: The Penguin Business Dictionary, 3rd edt.