Cost-output Relationship & Economies & Diseconomies of Scale

Cost-output relationship has 2 aspects:

Cost-output relationship in the short run, Cost-output relationship in the long run

The SR is a period which doesnt permit alterations in the fixed equipment (machinery , building etc) & in the size of the org. The LR is a period in which there is sufficient time to alter the equipment (machinery, building, land etc.) & the size of the org. output can be increased without any limits being placed by the fixed factors of production

Cost-output Relationship In The Short Run

Short Run may be studied in terms of Average Fixed Cost Average Variable Cost Average Total cost

 Total, average & marginal cost

Fixed cost & variable cost

1. Total cost (TC) = TFC + 1.Total fixed cost (TFC) TVC, rise as output rises = cost of using fixed factors = cost that does not change 2. Average cost (AC) = when output is TC/output changed, e.g. 3. Marginal cost (MC) = 2. Total variable cost change in TC as a result (TVC) = cost of using of changing output by variable factors = cost one unit that changes when output is changed,

Average Fixed Cost and Output The greater the output, the lower the fixed cost per unit, i.e. the average fixed cost. Total fixed costs remain the same & do not change with a change in output.

Average Variable Cost and output The avg. variable costs will first fall & then rise as more & more units are produced in a given plant. Variable factors tend to produce somewhat more efficiently near a firms optimum output than at very low levels of output. Greater output can be obtained but at much greater avg variable cost. E.g. if more & more workers are appointed, it may ultimately lead to overcrowding & bad org. moreover, workers may have to be paid higher wages for overtime work.

Average Total cost and output Average total cost, also known as average costs, would decline first & then rise upwards. Average cost consists of average fixed cost plus average variable cost. Average fixed cost continues to fall with an increase in output while avg. variable cost first declines & then rises.

 So , as Avg. variable cost declines the Avg. total cost will also decline. But after a point the Avg. variable cost will rise. When the rise in AVC is more than the drop in Avg. fixed cost that the Avg. total cost will show a rise.

Cost-output Relationship In The Long-Run

 long run period enables the producers to change all the factor & he will be able to meet the demand by adjusting supply. Change in Fixed factors like building, machinery, managerial staff etc.. All factors become variable in the long run. In the long run we have only 3 costs i.e. total cost, Average cost & Marginal Cost

1. Total cost (TC) = TFC + TVC, rise as output rises 2. Average cost (AC) = TC/output 3. Marginal cost (MC) = change in TC as a result of changing output by one unit

 When all the short run situations are combined, it forms the long run industry. During the SR, Demand is less & the plants capacity is limited. When demand rises, the capacity of the plant is expanded. When SR avg. cost curves of all such situations are depicted, we can derive a long run cost curve out of that. We can make a LR cost curve by joining the tangency points of all SR curves

 We use long run costs to decide scale issues, for example mergers. In the long run, we can build any size factory we wish, based on anticipated demand, profits, and other considerations. Once the plant is built, we move to the short run. Therefore, it is important to forecast the anticipated demand. Too small a factory and marginal costs will be high as the factory is stretched to over produce. Conversely too large a factory results in large fixed costs (e.g.. air conditioning, or taxes) and low profitability.

Economies & Diseconomies Of Scale

Economies Of Scale

 When a firm expands its size & goes for large scale production, it stands to enjoy certain benefits. Such advantages which arise due to large scale production are known as economies of scale. According to Marshal, there are 2 types of economies of scale. They are
Internal Economies of Scale External Economies Of Scale

 Internal economies Of scale: IE are those advantages of large-scale production which accrue to a firm on account of its superior techniques & management. Following are some of the IE of scale. Technical Economies Managerial Economies Marketing Economies Financial Economies Risk bearing Economies of scale

 External economies Of scale: when a particular industry grows in size & strength, it brings many advantages to all the firms within that industry. Those advantages which are available to all the firms are called the EE of scale. Following are some of the EE of scale. Economies of Localisation Economies of Information Economies of Specialisation

Diseconomies Of Scale

Diseconomies refer to the disadvantages suffered by a firm when it expands its production beyond the stage of optimum combination of factors or beyond the level of optimum output. Following are such diseconomies of scale: When the firm expands production beyond certain level. It develops many complexities. Effective management & smooth coordination at different levels become difficult.

 Beyond the stage of optimum production, the efficiency of machinery & equipment declines. This is called the technical diseconomy Beyond certain point, the firm is compelled to pay higher wages to recruit labour. Consumption of raw material becomes costlier. It faces the problem of shortage of fuel, power, finance etc.

" VALUE HAS A VALUE ONLY IF ITS VALUE IS VALUED "

References: 1.Managerial economics KL Maheshwari 2.Rferesher course by Kamaraj 3. Managerial economics D.N.Dwivedi