Internal Diseconomies of Scale

Definition: Internal DOS are increases in costs that occur to a firm as a results of the expansion of the firm, which is the result of the firm's own policies and actions.

Beyond the optimum size of production (minimum of LRAC), diseconomies of scale cause LRAC to rise.

i. Complexity of Management

Large firms are more complex in organisation than small firms and require more skillful entrepreneurs and managers. It is difficult to find entrepreneurs and mangers whoa re capable of effectively co-ordinating and controlling very large enterprises. Moreover, as firms expand, ownership and management become more divorced, which may in turn result in principal-agent problem.Incentives for managers to reduce costs to increase profits may diminish.

A long chain of authority can lead to a rigid organisational system, leading to time lags in implementing decisions. This results in a loss of efficiency and higher costs. Moreover, extensive red-tape will slow down responses to changes in demand and supply.

ii. Strained relationships

When firms become too large, relationships tend to become impersonal. The relationship between management and employees is important for maintaining productivity and efficiency. A long chain of authority in large firms may lead to workers to feel that they are only a small cog in a very large machine and thus have no personal loyalty to the firm, leading to slacking, apathy and even strikes. Average costs could then rise.