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Lecture 6

Scale of Production

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Scale of Production

The scale of production has an important bearingon the cost of production

It is the manufacturers common experience thatlarger the scale of production

The lower generally is the cost of production

That is why entrepreneur is tempted to enlarge

the scale of production so that he may benefitfrom resulting economies of scale

These economies are of two types

External economies

Internal economies

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Economies of Large Scale Production Efficient Use of Capital Equipment

There is large scope for the use of machinery which results in lower costs

Economy of Specialized Labour Specialized labour produces a larger output and of better quality

Better Utilisation and Greater Specialization in Management a capable manager is under-utilized in a small concern

Economies of Buying and Selling Good rates while buying raw materials and high net profits on large sales

Economies of Overhead Charges The expenses of administration and distribution per unit are much less in big units

Economy in Rent A large-scale producer makes a saving in rent too

Experiments and Research Big concerns can spend a lot on research activities which pay back in long run

Advertisement and Salesmanship Can spend on advertisement

Utilization of By-products By products can be utilized in big concerns

Meeting Adversity A big business can show resistance in time of adversity

Cheap Credit Bank give cheap credit to big concerns

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Diseconomies of Scale Overworked Management

A large scale producer cannot pay attention to every detail

Individual tastes Ignored

Large scale of production is of uniform quality so individual tastes areignored

No Personal Element

Managed by employees so no personal interest

Possibility of depression Large scale production may result in over production

Dependence on foreign markets

Large scale of production is normally dependent on foreign markets

Cut-throat competition

large scale producers fight for markets International complications and war

Large scale production at international level may give rise tointernational conflicts and may lead to war

Lack of adaptability

It is difficult for large scale units to shift from one business to another

while easy for small business

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Types of Economies

Internal Economies

External Economies

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Internal Economies

Internal Economies are those economies inproduction or reduction in production costs Which accrue to the firm itself when it expands its

output or enlarges its scale of production

The internal economies arise with a firm as aresult of its own expansion independent of thesize and expansion of the industry

Internal economies may be of the following types

Technical economies

Managerial economies

Commercial economies

Financial economies

Risk-bearing economies

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Technical Economies

There are four ways in which technicaleconomies can arise

Large size

Economies arise when large machines are used

E.g. big boiler, big furnace

Linking process

A dairy may have its own fodder farm or a sugar factory

has its own sugarcane farm

Superior technique

Superior technologies

Increased specialization

Specialization and division of labour are advantageous

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Managerial Economies

These economies arise from the creation of

special departments or from functional

specialization

They are also resulted from delegation of

routine and detailed matters to subordinates

This is vertical division of labor. However there

can be horizantal division of labour

By placing each division under an expert

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Commercial Economies

They arise from the purchase of materials andsale of goods

Large businesses have bargaining advantages and

are accorded a preferential treatment by the firmsthey deal with

They are able to secure freight concessions fromrailway and road tranport

Cheap credit from banks Prompt delivery

Careful attention

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Financial Economies

These economies arise form the fact that a big

firm has better credit and can borrow on more

favourable terms.

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Risk-bearing Economies

A big firm can spread risks and can often

eliminate them

This is done by diversifying output Diversification imparts it strength and stability

and takes it less vulnerable to changes in

commercial fortunes

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External Economies

External economies are those economies whichaccrue to each member firm as a result of theexpansion of the industry as a whole

Expansion of an industry may lead to theavailability of new and cheaper raw materials,tools and machinery and discovery and diffusionof a superior technical knowledge

There are various types of external economies Economies of concentration

Economies of information

Economies of disintegration

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Economies of Concentration

These economies relate to advantages arising

from the availability of

Skilled workers

The provision of better transport and credit

facilities

Stimulation of improvements

Benefits from subsidries

Scattered firms do not enjoy such economies

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Economies of Information

These economies refer to the benefits which

all firms engaged in an industry derive

From the publication of trade and technical

journals and

from central research institute

Each individual need not incur expenditure on

research. It can draw such benefits from

common pool

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Economies ofDisintegration

When an industry grows, it becomes possible

to split some of the processes which are taken

over by specialist firms

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Relationship between IE and EE

No hard and fast line can be drawn between the two

Internal economies are the result of expansion ofindividual firms while external economies are the

result of expansion or development of whole industry There can also be diseconomies if some inefficient

factors are brought in while expansion in a firm or in anindustry

If scale of production is increased it brings ineconomies of scale. However, if it is increased beyondlimits the economies of scale would be converted indiseconomies of scale

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Production Possibility Curve

&

Production Function

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Production Possibility Curve

The production possibility curve shows themaximum out put of any one commodity thatthe economy can produce together with the

prescribed quantities of other commoditiesproduced and resources utilized

In short, the production possibility curve tellsus what assortment of goods and services theeconomy can produce with the resources andtechniques at its disposal

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Example

Production Possibilities Goo1d X

(thousands)

Good Y

(thousands)

A 0 15

B 1 14

C 2 12

D 3 9

E 4 5

F 5 0

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Production Possibility Curve

A curve depicting all maximum output possibilities for two or moregoods given a set of inputs (resources, labor, etc.). The PPF assumesthat all inputs are used efficiently

At point X resources are not being efficiently utilized

Point Y is not reachable under given resources

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Marginal Rate of Transformation

In order to produce more X we must sacrificesome Y

The rate at which one product is transformed into

another is called marginal rate of transformation

For instance marginal rate of transformation

between good X and good Y is the amount of Y

which has to be sacrificed for the production of X

The MRT increases as Y is produced more andmore . That is why the production possibility

curve is concave

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Iso-Revenue Line

The iso-revenue line is the bundles of outputsthat return the same level of revenue.

It represents the rate at which the market is

willing to exchange one product for another.

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Production Function Production Function may be defined as the functional relationship between

physical inputs (i.e. factors of production) and physical outputs (i.e. the

quantity of goods produced) It shows the maximum amount of output which can be produced from a

given set of inputs in the existing state of technology

Production function depends on

Quantities of resources used

State of technical knowledge

Possible processes

Size of the firms

Nature of firms organization

Relative prices of the factors of production and the manner in which thesefactors are combined

With the change of these factors production function will also change Production Function can be expressed as

X=f(a, b, c, d, ..) X is the output of a commodity per unit of time

a,b,c,d are the various productive resources

f is the fucntion

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Important Points in PF

Purely technical relationship

Input with output

No reference to money price

The output is the result of a joint use of thefactors of production

The combination of inputs depends on

technology Variability of the factors of production is

considered while defining production function

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Types of Production Function

Fixed Proportion Production Function Factors of production are used in definite fixed

proportions

For example a fixed number of workers are

required to produce a given unit of output. This

proportion cannot be varied by substituting one

factor for another

Variable Proportion Production Function The technical coefficient of production is variable

Substitution of factors possible

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Quiz What an indifference curve shows and why it

is convex to the origin?

Show Income Effect, Price Effect and

Substitution Effect through indifference curveanalysis and explain it?

What is elasticity of demand? Please Explaindifferent cases and types of elasticity of demand.