As the scale of operations of a firm increases and many firms start getting localized in a particular area, a number of facilities and advantages which accrue to all the firms situated in a particular area, with the general expansion of industry in their area, are known as external economies. The individual firms may have done nothing to achieve those advantages. But they come automatically with the expansion of the industry. A few facilities resulting from external economies are:
Development of Efficient Transport and Communication. One such external economy is that of transport and communication. When a large number of firms get localized in a particular area, the government may provide transport and communication facilities. It may open up a railway line, or a new railway station or it may connect that place with the market by building up a new road. All this would facilitate the purchase and sale of goods and reduce their cost of production.
Growth of Subsidiary and Ancillary Industries. Subsidiary and ancillary industries may crop up, which may use the by – products of these firms, or which may supply semi finished goods to them. They may also take up some further processes of production and hence turn out finished products at a cheaper rate. For example, if sugar factories get concentrated at one particular place, then some firms may get settled there to use molasses to produce alcohol. Firms specializing in the repair of machines used in sugar industry may also come and render their services. All this would lead to some reduction in the cost of producing per unit of sugar.
Growth of Banks and Financial Institutions. Next, a general expansion of industry in a particular area may lead to the setting up of banks and other financial institutions which may provide facilities for cheap borrowing of funds. These institutions would be in a position to lend adequate finances at competitive rates of interest.
Development of Training Facilities. And finally, at those places where the industry has been localized, a large number of institutions, rendering technical knowledge and imparting training in these branches of industry may be established. This would lead to an easy availability to skilled labour, qualified technicians and trained personnel. All this is bound to reduce the cost of production.