Economies of Scale

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ECONOMIES OF SCALE AND PRODUCTION:

ECONOMIES OF SCALE AND PRODUCTION LARGE SCALE OF PRODUCTION The scale of production means the size of the production unit of a firm or a business establishment. Scale of Production – very small to very large depending upon the quantity of OP per unit of time of the firm. Scale varies with size of the firm. With Large scale production require large Input and vice versa. ADVANTAGE Large scale production that result in lower point (average) Costs(cost per unit) AC =TC/Q Economies of scale –spread total costs over a greater Range of output

Motives Behind Large Scale Production:

Motives Behind Large Scale Production Desire for Economy Desire for Large profit Desire for Economic Power and Prestige Desire for Increase Demand Desire for Self-Defense in competitive Market

DEFINITION:

DEFINITION “ Economies of Scale characterize a production process in which an increase in the scale of the firm causes a decrease in the long run average cost of each unit.” it is measure in Money terms. Classification Internal Economies : Economies which are open to an individual firm when its size expands. The cost per unit depend s on the size of the individual firm. External Economies : Economies which are shared by all the firms in an industry or in a group of industries when their size expands. The cost per unit depends on the size of the industry not the firm.

Size of the Firm and Industry:

Size of the Firm and Industry Size of a firm is measured by the value of its output or by the number of laborers it employs, or by the amount and value of its fixed capital such as buildings, plant and equipment. The size of an industry depends on the size of firms it constitutes and their number. Industry consists of large and small firms. Thus, the size of an industry increases when: There is an increase in the number of firms in it or There is an increase in the size of firms comprising it.

FORMS OF INTERNAL ECONOMIES:

FORMS OF INTERNAL ECONOMIES Labour Economies Technical Economies Economies of Superior Technique Economies of Increased Dimension Economies of Linked Process Economies in Power Economies of By-product Economies of Continuation Managerial Economies Marketing Economies Financial Economies Economies of vertical Integration Over Head Economies Transport and Storage Economies Risk-Minimising Economies By diversification of OP By Diversification of Market By Diversification of Sources of Supply as well as Process of Manufacturing

FORMS OF EXTERNAL or PECUNIARY ECONOMIES:

FORMS OF EXTERNAL or PECUNIARY ECONOMIES Economies of localization or Concentration or Agglomeration Economies of Information or Technical and Market Intelligence Economies of Vertical Disintegration Economies of By-product

LABOUR ECONOMIES:

LABOUR ECONOMIES Increased division of labour. Increase output and grow labour force. Attract more efficient labour and offer wide vertical mobility and specialisation. Better prospects of promotion. Efficiency and productivity of labour increased. It also reduces the cost per unit of output.

TECHNICAL ECONOMIES:

TECHNICAL ECONOMIES Definition : Technical economies refer to reductions in the cost of the manufacturing process it self. These relates to methods and techniques of production, especially to the nature and forms of capital employed . Types of Technical economies Economies of Superior Technique Economies of Increased Dimension Economies of Linked Process Economies in Power Economies of By-product Economies of Continuation Inventory Economies

Slide 9:

Economies of Superior Technique: As a firm expends, it can use superior techniques and capital goods. A small firm cannot install a high –quality machine or other capital goods which a big firm can use. Ex: In textile industry for instance an automatic loom is more economical than handloom. Economies of Linked Process It is the arranging production activities in a continuous sequence with out any loss time. It is the time saving and transport cost saving. It means production cost decrease. For example – the same reason process of editing and printing of News papers are generally carried out in same premises.

Slide 10:

Example of the economies of linked process In the iron and steel company : Melting iron ore Mild steel Pig iron Rolling steel Sheet plate Etc. These are linked together to avoid waste of power, heating process and, thus to achieve economies

Slide 11:

Economics in Power Large unit of machines and their running by a large firm are often more economical in their power consumption as compared to small machine . Economies of Increased Dimension Large pieces of equipment are relatively more economical than smaller ones and usually there is an optimal minimum to the size any piece of equipment. The reason for this lies in the laws of physical universe which govern the rate of increase of the various properties of inanimate bodies with an increase in their size. Ex :- A double-decker bus is more economical than a single decker -bus. Economies of By-products : Large firms can make a more economical use of their raw materials, which it can economically use for manufacturing certain by-products. Large chemical companies are for instance constantly developing new varieties of by-products like cane pulp and molasses of sugar factories are used in paper and liquor industries.

Economies of Continuation: Technical economy is also realized due to long run continuation of the process of production. Example: In the printing press industry ,there is an apparent economy to be realized by printing more copies of a composed sheet . Thus, if composing and printing cost of 1000 copies per page is Rs .12 for 2000 copies it would cost only Rs.14 that is just Rs. 2 more for the extra 1000 copies, because the same sheet plate which is composed once will remain in use for printing extra copies. Hence, there is only additional printing cost involved while the composing cost remains the same. Inventory Economies: A part of materials management Example: Just-In-Time or Zero level inventory techniques. Rationale is to ask the seller of the inputs to supply them just before the commencement of work in the production department each day instead of having huge stocks worth of lakhs. :

Economies of Continuation: Technical economy is also realized due to long run continuation of the process of production. Example : In the printing press industry ,there is an apparent economy to be realized by printing more copies of a composed sheet . Thus, if composing and printing cost of 1000 copies per page is Rs .12 for 2000 copies it would cost only Rs.14 that is just Rs. 2 more for the extra 1000 copies, because the same sheet plate which is composed once will remain in use for printing extra copies. Hence, there is only additional printing cost involved while the composing cost remains the same. Inventory Economies : A part of materials management Example: Just-In-Time or Zero level inventory techniques. Rationale is to ask the seller of the inputs to supply them just before the commencement of work in the production department each day instead of having huge stocks worth of lakhs.

Managerial Economies:

Managerial Economies Delegation of details Functional Specialization As a result of the indivisibility of managerial factors, the cost per unit of management will fall as OP increases, thus, with increasing scale of OP, greater managerial economies are enjoyed by an expanding firm. Good manager can organize a large OP with the same efficiency as he can organize a small OP. Remuneration same whether OP is small or large. Delegation of work to his trained and specialized personnel in his various departments results in efficient productive management with scientific business administration.

MARKETING OR COMMERCIAL ECONOMIES :

MARKETING OR COMMERCIAL ECONOMIES Marketing economies are the economies of buying of raw materials and selling goods produced . Large farm can buy more cheaply By paying wholesale price -Bulk buying By employing purchasing experts-Specialist buyers Branding Specialist transport Sales out let – Large scale marketing Advertising

FINANCIAL ECONOMIES:

FINANCIAL ECONOMIES Large firms have a wider reputation and greater influence in the money market. Large firms would be able to negotiate cheaper finance deals. be more flexible about finance –share options , right issues, etc. utilize skills of merchant banks to arrange finance borrow money at lower rates of interests than smaller firms. raise capital easily by issuing shares and debentures. have a ready market for its shares.

Slide 16:

Economies of vertical Integration Benefits increase when integration of a number of stages of production is achieved. Flow of goods is more readily controlled leading to controlled costs(reduction in costs) Over Head Economies On account of large scale operations expenses on establishment, administration, book-keeping are more or less same. Hence cost per unit is low. Transport and Storage Economies Arise on the account of the provision of better, highly organized and cheap transport and storage facilitates and their complete utilization. Can own fleet of vehicles. Can have own storage facilities.

Risk-Minimizing Economies:

Risk-Minimizing Economies A large firm by producing a wide range of products is in a position to eliminate or minimize business risks by spreading them over in the following ways: By Diversification of OP of Market of sources of Supply as well as Process of manufacturing

External Economies:

External Economies Economies of Localization: When a number of firms are located in one pace, all of them derive mutual advantages through the training of skilled labour, provision of better transport facilities, stimulation of improvements, etc. Concentration of a particular industry in one area, results in the development of conditions helpful to the industry. All firms reap mutual benefits. Economies of Information or Technical and Market Intelligence Large and growing industry can bring out trade and technical publications to which every firm can have the access Each firm can enjoy the benefit of the research work. Can save from independent research work or data collection. Statistical, future trends, technical and other market information is available to all firms in a growing industry. As a result cost of production decreases .

Slide 19:

Economies of Vertical Disintegration: When a particular process in a industry is split up and performed on a large scale by a specialized firm, then it’s calls vertical disintegration. New subsidiary industries grow to serve the main industry which results in lower cost. Economies of By-product: A number of Industries can use the waste material produced in their factory to manufacture By-products. The firm using it can flourish when waste material available in it is converted in to by-products. Industry also can sell these waste material to other industries which use it as raw material & can gain profit. This means an indirect economy in cost.

DISECONOMIES OF SCALE:

DISECONOMIES OF SCALE Definition: A diseconomy of scale is the opposite of an economy of scale. If some cost of a business rises with an increase in size, by a greater proportion than the increase in size, it is a diseconomy of scale. Diseconomies act as limits to large scale production.

Factor of Diseconomies:

Factor of Diseconomies Difficulties of Management Difficulties of coordination Difficulties of Decision Making Increased Risks Labour Diseconomies Scarcity of Factor Supplies Financial Difficulties Marketing Diseconomies

Difficulties of Management:

Difficulties of Management As the firm develops, the problems for management also increases . After a certain point, the manager himself finds difficult to control the whole organization. The entrepreneur and the manager cant maintain a good rapport with all the departments of large concern. The problem of supervision becomes rather difficult and intractable. This leads to increasing possibilities of mistakes and mismanagement 2/17/2011

Difficulties of Coordination:

Difficulties of Coordination With the increase in the size of the organization, the tasks progressively becomes more and more difficult. This creates a problematic situation in decision making and organizing. This may leads to disturb the individual time allotment to clear the problems. Decisions taken in hurry may leads to inefficiency and increase in cost of goods.

Difficulties in Decision Making:

Difficulties in Decision Making A large firm cant take quick changes and decisions when they are needed, it has to share with all the departments to take, and this needs a required timely decisions are inevitably delayed. This may leads some loss to firm. 2/17/2011

As a scale of production increase, investment also increase, so too the risk of business. The larger output, obviously the greater will be the loss. It is the important limitation to increase the size of the firm. :

As a scale of production increase, investment also increase, so too the risk of business. The larger output, obviously the greater will be the loss. It is the important limitation to increase the size of the firm. INCREASED RISK

Extreme division of labor with a growing scale of output result in lack of initiative and drive in a executive personnel. Thus the firm become more impersonal and contact between management and worker become less, which result into industrial dispute, which prove to be costly to the large firm. :

Extreme division of labor with a growing scale of output result in lack of initiative and drive in a executive personnel. Thus the firm become more impersonal and contact between management and worker become less, which result into industrial dispute, which prove to be costly to the large firm. LABOR DISECONOMICS

Slide 27:

SCARCITY OF FACTOR SUPPLIES: Due to the increase in the concentration of firms in a particular locality, each firm will find scarcity of available factors. Hence competition among firms in purchasing labor, raw materials etc. will result in increased factor prices. Thus, extreme concentration of external economies becomes a sort of diseconomy in the form of high factor prices. FINANCIAL DIFFICILTIES A big concern needs huge capital which cannot always be easily obtainable. Hence the difficulty in obtaining sufficient capital frequently prevents the further expansion of such firms. MARKETING DISECONOMIES When the industry expands and the firm grows, competition in the market tends to become stiff. Thus, firms under monopolistic competition will have to undertake extensive advertising and sales promotion efforts and expenditure which ultimately lead to higher costs.

Managers Per Operative Ratio ( MOR):

Managers Per Operative Ratio ( MOR) Empirical evidences usually show that unit cost tend to decrease with the increasing scale of output, thus, supporting the hypothesis of economies of scale. The empirical evidence of diseconomies of scale may not be easy to detect on account of changing state of technology. Existence of managerial diseconomies, however, can be inferred by comparing the “ Managers Per Operative Ratio (MOR) in different organizations with different size. Manager per operative ratio is a tool to safe guard from managerial diseconomies. It is a ratio which shows the relationship between number of employee & number of managerial staff in the organization . It help the business unit or firm to determined how many should be the manager for particular number of employee to increase the profitability of the firm.

The managers per operative by firm size:

The managers per operative by firm size Firm size Manager per operative (MOR) ratio 1-100 100- 200 200-500 500-700 700-1500 1500-2500 2500-3000 0.39 0.42 0.44 0.47 0.51 0.60 0.67 -------------------------------------- --------------------------------------

Economies of Scope:

Economies of Scope It refers to the reduction in unit cost realized when the firm produces two or more products jointly rather then separately. A multi –product firm often experiences economies of scope leading to the lowering to the cost. It exist when a firm produces two or more products together under the same production facilities as against producing them under separate facilities. It reflects in the lesser cost or cost economy. Example- Onida to produce TV set and DVD player utilizing single assemble plant to produce these good at two separate ,less intensively used plants It may be prove to be less expensive or more economical It is realized by avoiding duplication of the factor inputs in certain ways under a joint operation as compared to separate operation. TC(Q x , Q y ) < TC(Q x , 0) + TC (0, Q y )

Slide 31:

DEGREE OF ECONOMIES OF SCOPE(DES): It can be measured in terms of the difference in the costs of production jointly and separately. The formula used to measure the degree of economies of scope is DES= TC(An)+TC(Bn)-TC(An+Bn) TC(An+Bn) where, DES=Degree of economies of scope. TC(An)=total cost of producing An units of product A separately TC(Bn)=total cost of producing Bn units of product B separately TC(An+Bn)=total cost of producing products A and B jointly

Slide 32:

Positive value of DES indicates existence of economies of scope. Negative value of DES implies diseconomies of scope. Negative DES suggests that it is more economical to produce two goods separately than jointly.

X-Efficiency:

X-Efficiency X-efficiency refers to the phenomenon of the firm’s ability to monitor and control the production unit to minimize the wastage of resources. X-efficiency is a function of management to reduce or minimize the waste of resources in operation. Effectiveness with which a given set of inputs are used to produce outputs. If a firm is producing the maximum output it can, given the resources it employs, such as men and machinery, with the best technology available. Use in Business New managerial approaches such as six-sigma Methodology’ [as adopted by Motorola, general electrics and many other organization] are essentially meant towards attainment of x-efficiency of the business firm.

LEIBENSTIEN'S THEORY OF X-EFFICIENCY:

LEIBENSTIEN'S THEORY OF X-EFFICIENCY EFFORRT firm gets more effort In a avg. for less wages Surroundings, signifying That the employee gets more PD outcome wages for less effort Pure c Prisoner’s dilemma Solution: No effort, no wages WAGES As pressure mounts, the circle reduces in size and wages reflect effort more and more accurately; with perfect information and honesty, the equilibrium is on the 45 line, where wages reflect effort.

Criticisms Of X-Efficiency:

Criticisms Of X-Efficiency All economic agents are rational, any slack is a rational leisure-income trade-off. Higher costs, therefore, are not a symptom of inefficiencies, but the effect of fully rational workers' preferences for leisure. The internal pressure is a greater influence than the external pressure.

DEFINATION OF LEARNING CURVE:

DEFINATION OF LEARNING CURVE Learning Curve refers to a relationship between the duration of learning or experience and the resulting progress. The theory of the Learning curve is based on the simple idea that the time required to perform a task decreases as a worker gains experience. Learning curves are useful for preparing cost estimates , special orders , setting labor standards, evaluating labor performance and setting incentive wage rates. Mostly Learning curves are determined in percentage and it ranges from 70% - 100%. The Learning curve express the relationship between experience and efficiency.

APPLICATIONS OF LEARNING CURVE:

APPLICATIONS OF LEARNING CURVE Labour efficiency. Technology-driven learning. Better use of equipment. Product redesign. Network building. Standardization and specialization. Shared experience effects.

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