Cost & Production Final | Production Function | Long Run And Short Run

# Chapter V Production & Cost Analysis

Dr. GOPALAKRISHNA B.V. Faculty in MBA, SDM, Mangalore

• Production is the creation of goods & services by organising land, labour & capital. • The aim of production is supply of goods & services for consumption. • So production is the act of creating utility or value. • It conversion of inputs into output – i.e., transforming physical input into physical output. • Law of production are explained in connection with production functions. A production function explains the relationship between factors of production (physical

Definition of production function • G.J. Stigler – the production function is the name given to the relationship between the rate of input of productive services & the rate of output of product. • Prof Leontief – a production function is the name given to the relationship between the rate of input of productive services & the rate of output of product. It is the economist’s summary of technological knowledge. • Prof Watson – production means the transformation of inputs into outputs. The production function is the name for the relation between the physical inputs and physical outputs of a firm. If a small factory produces hundred wooden chairs per eight hour shift, then its production function consists of the minimum quantities of wood, glue, varnish, labour time, machine time, floor space,

• Thus a production function explains the functional relationship between physical inputs & physical outputs of firms. • Algebrically, the production function can be expressed in equation in which the inputs are independent & output are dependent variable. • The common equation denoting a simple production function is the following ways – • Q = f (L, N, K)  Q = physical output  f = functional relationship  L = land  N= labour units  K = capital employed

Production Function

Inputs (L, K)

Production Function q = f(L, K)

Output q

• • Q = stands fro the rate of output of given commodity. • A, b, c, d ….n are different factors and services • f = functional relationship

Algebrical expression Q = f (a, b, c, d …..n)

Production function depends on

1.Quantities of resources (rawmaterials, labourers, capital, machinery etc). 2.State of technology is given. 3.Possible processes. 4.Size of the firms. 5.Nature of firms organization and 6.Relative price of inputs and the manner in which the inputs are combined.

Production function In economic theory, there are three types of production function, they are – 1.Production function with one variable input – The Law of Variable Proportions 2.Production function with two variable input – Iso-quant curves 3.Production function with all variable input – Law of Returns to scale

• • •

Production function with one variable input Production function with one variable input are also called as law of variable proportions. This law occupies an important place in economic theory. The law states a technical physical relationship between the fixed and variable factors of production in the short run. Here it is assumed that only one factor of production is a variable factor (labour) while other factor are

Assumptions of the law
1.The state of technology is assumed to be given and unchanged. 2.Only one factor is varied (labour) and all other factors remain unchanged (land, capital, equipment and rawmaterial etc). 3.The fixed factor and the variable factor are combined together in various proportions in the process of production. 4.The units of the variable factors are homogeneous. 5.The law operates in the short-run.

Table 5.1 Returns to Labour
Un it s o f La b o u r 1 2 3 4 5 6 7 8 9 10 To t a l P ro d u c t Ma rg in a l ( q u in t a ls ) P ro d u c t ( q u in t a ls ) 80 170 270 368 430 480 504 504 495 480 80 90 100 98 62 50 24 00 -9 -15 Av e ra g e P ro d u c t s ( q u in t a ls ) 80 85 90 92 86 80 72 63 55 48

Average and Marginal Product Curves
Total Product
TP AP max & AP = MP MP max L Point of diminishing marginal returns Point of diminishing average returns AP MP L

AP MP

L’

L”

Production with One Variable Input (Labor)
Outpu t per Month Observations: Left of E: MP > AP & AP is increasing Right of E: MP < AP & AP is decreasing E: MP = AP & AP is at its maximum Marginal Product

30

20

E

Average Product

10 10 Labor per Month

0

1

2 3

4

5

6

7 8

9

60 50 40 30 20 10 0
15 10 5 0 0 -5 2 4 6 8 10
Stage I Stage II Stage III

0

2

4

6

8

10

Three stages of the law of variable proportion
Stage I • Total product will increases at an increasing rate. • Average and marginal product also increase but marginal product rises at a faster rate than average product.
 

Stage II • Total product continues to increase but at a diminishing rate • Marginal product is diminishing and becomes equal to zero • Average product starts diminishing
 

Stage III • Total product starts declining • Marginal product becomes negative

Table 5.2 Behaviour of TP, MP and AP during three stages of production
Different Stages Total Product (TP) Marginal Product (MP) Increases, reaches its maximum and then declines till MR = AP It diminishing and becomes equal to zero Average Product (AP)

Stage I

Increases at an increasing rate Increases at a diminishing rate till it reaches maximum Starts declining

Increases and reaches its maximum Starts declining

Stage II

Stage III

Become negative

Continues to decline

2. Production Function with two variable inputs

• To understand a production function with two variable inputs, it is necessary to understand isoquant curve. • An isoquant is also known as isoproduct curve, which are similar to indifference curves analysis. • Isoquants are curves which represent the different combinations of two factors of production which are capable of producing the same level of output

Labour and capital inputs in relation to output
Factor Labour combination A 1 B C D E 2 3 4 5 Capital 5 3 2 1 0 Units of production 10 10 10 10 10

IQ

y

5
Capital

A B C D

Iso - quant Curve

3 2 1 1 2

IQ 3 4 x

0

Labour

• All those input combinations which are capable of producing the same level of output. • Isoquants are thus contour lines which trace the loci of equal outputs. • Since an isoquant represents those combinations of inputs which will be capable of producing an equal quantity of output. • Therefore, it is also called as production-indifference curve.

 

Types of Isoquants 1. Liner isoquants

• There is perfect substitutability of inputs. • For example – a given output say 100 units can be produced by using only capital or labour or combination of both labour and capital.

Units of outputs 100 100 100 100

Labor 1 2 3 4

Capital 5

A

2 1

Capital

3

B C D

Labour

2. Right angle isoquant

• There is complete non-substitutability between the inputs. • This is also known as Leontief isoquant or inputoutput isoquant. Y

Capital

Q3 Q2 Q1 O Labour X

3. Convex of isoquant curve This form assumes substitutability of inputs but the substitutability is not perfect. IQ
y

12
Capital

A B C D

Iso - quant Curve

8 5 3 1 2

IQ
0

3

4

x

Labour

Properties of isoquants

1.Isoquants slope downward from left to right 2.Isoquants are convex to the origin 3.Isoquants can neither touch nor intersect each other 4.Isoquants need not be parallel to each other, they may be parallel, they may not be parallel. 5.The higher isoquant shows the higher level of production.

Properties of Isoquants
1. Isoquants slope downward from left to right  When the quantity of one factor (labour) increased, the quantity of other capital must be reduced so as to keep output constant on a given isoquant. 2. No two isoquants can interest each other  Isoquant curve never cut each other as higher and lower curves show different levels of satisfaction.

Properties of Isoquants……
3. Isoquants curve are convex to the Origin § Iso-quant curve as similar to indifference curves are convex to the origin and they cannot be concave to the Origin. § The marginal rate of technical substitution are normally convex to the origin and it cannot be concave. § If the isoquants were concave to the origin – marginal rate of technical substitution increased as more and more units of labour are substituted for capital

IQ

y

12
Capital

A B C D

Iso - quant Curve

8 5 3 1 2

IQ
0

3

4

x

Labour

Y IQ 1

Capital

IQ 2

O

Labour

X

Marginal Rate of Technical Substitution
• The Marginal Rate of Technical Substitution (MRTS) production theory is similar to the concept of Marginal Rate of Substitution of Indifference curve analysis. • MRTS - indicates the rate at which factors can be substituted at the margin without altering the level of output • MRTS of labour for capital - defined as one number of units of capital which can be replaced by one unit of labour, the level of output remaining unchanged..

Marginal Rate of Technical Substitution
Factor Units of Combination Labour (L) Units of Capital (K) MRTS of L for K

A B C D E

1 2 3 4 5

12 8 5 3 2

4:1 3:1 2:1 1:1

IQ

y

12
Capital

A B C D

Iso - quant Curve

8 5 3 1 2

IQ
0

3

4

x

Labour

3. Production function with all variable input – law of returns to scale

§ The law of returns to scale describes the relationship between outputs & scale of inputs in the long run. § When all the inputs are increased in the same proportion output increased by different proportion – increasing return, constant return & diminishing return. § Prof Roger Miller – defined returns to scale refers to the relationship between changes in output & proportionate changes in all factors of production. § In the long run, due to change in demand, the firm increases its scale of production by using more space, more machines & labourers in the factory.

§ In the long run all factors of production are variable – no factor is fixed – all the factors treated as variable factors. § Accordingly, the scale of production can be changed by changing the quantity of all factors of production. § It all factors of production is doubled, the total output will also be doubled. § According to this law, when all factor units are increased, total product generally increases at an increasing rate, later at a constant rate and finally decreasing rate. §

Returns to Scale

Increasing Returns

Constant Returns

Decreasing Returns

Assumptions of law of returns to scale 1. All factors are variable but enterprise is fixed. 2. A worker works implements. with given tools &

3. Technological changes are absent. 4. There is perfect competition.

 

1. Increasing Returns to Scale

§ If the increase in all factors leads to more than proportionate increase in output – increasing returns to scale. § Thus, if all factors are doubled & output increases by more than double then the returns to scale are increasing. § For example – all inputs are increases by 25% & output increases by 40% then the increasing returns to scale will be prevailing. § This increase is due to many reasons like division of labour, specialisation and other external economies of scale.

Increasing returns to scale

Units of variable inputs 1 2 3 4

Total Marginal Product Product 20 60 120 200 20 40 60 80

Y IRS

Productivity

O No. units of labour and capital

X

§

§ §

§

2. Constant Returns to Scale If we increase all factors of production a given proportion & the output increases in the same proportion – constant returns to scale In simple terms, if factors of production are doubled output will also be doubled. In this case internal & external economies are exactly equal to internal economies & external diseconomies This is also known as Homogeneous Production Function or Cobb-Douglas Linear homogeneous production function

Constant returns to scale

Units of variable 1 inputs 2 3 4

Total Product 20 40 60 80

Marginal Product 20 20 20 20

Y

CRS

O

X

3. Diminishing Returns to Scale § If the increase in all factors leads to a less than proportionate increase in output – diminishing returns to scale § When a firm goes on expanding all its inputs, then eventually diminishing returns to scale will be occur.

Diminishing returns to scale

Units of Total variable Product inputs 60 1 2 100 3 120 4 120 5 100 6 60

Marginal Product 60 40 20 00 -20 -40

Y

Productivity

DRS O No. units of labour and capital X

Y

Returns to scale

Constant
Di m
In cr ea si ng

in is

hi ng

O

Scale of production

X

Returns to Scale

§ Total product (TP) – total physical product refers to the total output of a commodity produced by the combination of fixed factors and variable factor. § Average product (AP) – it is calculated by dividing the total output by the number of fixed & variable inputs used. § Marginal product (MP) – refers to the additional output i.e., addition to the total output from the use of an additional factor.

A R

B

C

Productivity

D C R

R I

Units of labour & capital

Cost analysis & cost function

§ The relationship between cost & output is known as the cost function. § Cost play a very significant role in managerial decisions involving a selection between alternative course of action. § Costs enter into almost every business decision & it is important to use the right analysis of cost. § Price determination of a commodity with the help of demand & supply factors, where as price of commodity influenced by cost of production.

§ Cost of production means the actual expenditure incurred for acquiring or producing a goods or service. § Cost of production directly influences on production function as well as the price determination of a commodity.  Types of costs of production
1. 2. 3. 4. Money cost & real cost Implicit cost & explicit cost Short run cost & long run cost Total cost, marginal cost & average cost

§

§

§ §

1. Money cost & real cost Money cost are also called as nominal cost. The money cost refers to total money expenses incurred by a firm in producing a commodity. It includes – cost of raw-material, wages & salaries of labour, expenditure on machinery & equipment, depreciation on machines, building & such other capital goods, advertisement expenditure etc. Real cost is a subjective concept. It expresses the pains & sacrifices involved in producing a commodity. Marshal, argues that real cost of production of a commodity is expressed

§

§

§ §

2. Implicit cost & explicit cost Implicit cost are the imputed value of the entrepreneur’s own resources & services. In other words, implicit costs are costs which self-owned & self-employed resources could have earned in their best alternative uses. Explicit cost are those costs which are actually paid by the firm. Explicit cost include wages & salaries, prices of raw-materials, amounts paid on fuel, power, advertisement, transportation, taxes & depreciation charges.

§ Short run is a period in which a firm cannot change its plant, its equipment & the scale of production. § In short period, a firm can increase its output only by varying the amount of variable factors such as labour & capital. § In the short period, two types of cost existed fixed cost & variable cost. § Fixed costs are the costs for fixed inputs/factors such as land - building machinery and tools etc. § Variable costs are the costs for the variable factors like prices of rawmaterials, prices of electricity, water and wages & salaries for the labours.

3. Short run cost & long run costs

Short run costs

Short run total cost

Short run average cost

Short run marginal cost

Total fixed cost

Total variable cost

Average fixed cost

Average Variable cost

§

§ § §

§

1. Short run total cost Short run total cost refers to the overall expenses made by the firm in order to produce a commodity at given output. Short run total cost consists total fixed cost (TFC) & total variable cost (TVC). Therefore, it expressed in terms of TC = TFC + TVC. Total fixed cost – related to the expenses incurred for fixed factor such as capital, machinery, land, management etc. Total fixed cost remains the same, whatever be the level of output.

§ Even no production, firm incurring some cost such as salaries for security guards, rent for land & building, electricity charges and water charges etc. § Total variable cost (TVC) – vary with the level of output. These costs are incurred on the employment of variable factors of production such as labour, rawmaterials. § They are incurred when the factory is at work. § The TVC will incurs with the increase

Y

Cost

TFC

O

Output

X

Short run variable costs

Y

Short run variable cost

O

output

X

2, Short run average cost

§ Average cost is the cost per unit of output produced. It is cost per unit of output produced. § Average cost per unit of output is the total cost divided by the number of units produced. STC C §
= § No unit produced X § § § Short run average cost has two types average fixed cost & average variable cost.

SAC =

average fixed cost (AFC) § Average fixed cost is nothing but average cost which is obtained by dividing the total cost by the quantity produced. § AFC = total fixed cost = TFC  total output X
 

Average variable cost § Average variable cost is the total variable cost divided by the number of units produced. § It is calculated by using the following formula = TVC AVC
 

Output

§ §

§ §

Cost analysis & cost function The relationship between cost & output is known as the cost function. Cost play a very significant role in managerial decisions involving a selection between alternative course of action. Costs enter into almost every business decision & it is important to use the right analysis of cost. Price determination of a commodity with the help of demand & supply factors, where as price of

§ Cost of production means the actual expenditure incurred for acquiring or producing a goods or service. § Cost of production directly influences on production function as well as the price determination of a commodity.  Types of costs of production
1. 2. 3. 4. Money cost & real cost Implicit cost & explicit cost Short run cost & long run cost Total cost, marginal cost & average cost

§

§

§ §

1. Money cost & real cost Money cost are also called as nominal cost. The money cost refers to total money expenses incurred by a firm in producing a commodity. It includes – cost of raw-material, wages & salaries of labour, expenditure on machinery & equipment, depreciation on machines, building & such other capital goods, advertisement expenditure etc. Real cost is a subjective concept. It expresses the pains & sacrifices involved in producing a commodity. Marshal, argues that real cost of production of a commodity is expressed

§

§

§ §

2. Implicit cost & explicit cost Implicit cost are the imputed value of the entrepreneur’s own resources & services. In other words, implicit costs are costs which self-owned & self-employed resources could have earned in their best alternative uses. Explicit cost are those costs which are actually paid by the firm. Explicit cost include wages & salaries, prices of raw-materials, amounts paid on fuel, power, advertisement, transportation, taxes & depreciation charges.

§ Short run is a period in which a firm cannot change its plant, its equipment & the scale of production. § In short period, a firm can increase its output only by varying the amount of variable factors such as labour & capital. § In the short period, two types of cost existed fixed cost & variable cost. § Fixed costs are the costs for fixed inputs/factors such as land - building machinery and tools etc. § Variable costs are the costs for the variable factors like prices of rawmaterials, prices of electricity, water and wages & salaries for the labours.

3. Short run cost & long run costs

Short run costs

Short run total cost

Short run average cost

Short run marginal cost

Total fixed cost

Total variable cost

Average fixed cost

Average Variable cost

§

§ § §

§

1. Short run total cost Short run total cost refers to the overall expenses made by the firm in order to produce a commodity at given output. Short run total cost consists total fixed cost (TFC) & total variable cost (TVC). Therefore, it expressed in terms of TC = TFC + TVC. Total fixed cost – related to the expenses incurred for fixed factor such as capital, machinery, land, management etc. Total fixed cost remains the same, whatever be the level of output.

§ Even no production, firm incurring some cost such as salaries for security guards, rent for land & building, electricity charges and water charges etc. § Total variable cost (TVC) – vary with the level of output. These costs are incurred on the employment of variable factors of production such as labour, rawmaterials. § They are incurred when the factory is at work. § The TVC will incurs with the increase

Y

Cost

TFC

O

Output

X

Short run variable costs

Y

Short run variable cost

O

output

X

2, Short run average cost

§ Average cost is the cost per unit of output produced. It is cost per unit of output produced. § Average cost per unit of output is the total cost divided by the number of units produced. STC C §
= § No unit produced X § § § Short run average cost has two types average fixed cost & average variable cost.

SAC =

average fixed cost (AFC) § Average fixed cost is nothing but average cost which is obtained by dividing the total cost by the quantity produced. § AFC = total fixed cost = TFC  total output X
 

Average variable cost § Average variable cost is the total variable cost divided by the number of units produced. § It is calculated by using the following formula = TVC AVC
 

Output

Average cost = AFC + AVC

3. Marginal cost • Marginal cost is an addition to the total cost caused by producing one more unit of output. Change in TC • Marginal cost =
 

Change in output

MC = TC q

Long run cost

§ The long run is a period in which a firm can change its plant, equipment & the scale of production. § It is a period which is sufficiently long enough to bring about changes in all the factors of production. § Thus, in the long run all the factors of production are variable. § There is no classification of costs in the long run as fixed & variable as in the short period. § In the long run machinery, land, equipment can be changes due to

Long run cost

Long run total cost

Long run average cost

Long run marginal cost

Long run total cost Long run total cost is always less than or equal to short run total cost, but it is never more than short run total cost Long run average cost § The long run average cost is the long run totalLTC cost divided by the level of output § LAC = Q Long run marginal cost § Long run marginal cost shows the change in total cost due to the production of one TC more unit of commodity. Q  LMC =

LTC 1

LTC 2

cost

LTC 3

Output

Economies of Scale

• In modern days, the size of the business undertakings has greately increased & production on a large scale is a very important feature of modern industrial society. • Large-scale production offers certain advantages which help in reducing the cost of production. • It is a common experience of every producer that costs can be reduced by increased production. That is why the producers are more keen on expanding the size/scale of production. • Economies of scale have been classified by Marshall into – internal and external

Economies of Scale

Internal Economies

External Economies

Internal Economies Technical Economies Managerial Economies Labour Economies Financial Economies Marketing Economies Economies of R & D Economies of Welfare Risk Spreading Economies

External Economies

Economies of concentrati on Economies of information Economies of disintegrat ion

Internal Economies

• Internal economies are those economies production which accrue to the firm when it expands the output, so that the cost of production would come down considerably and place the firm in a better position to compete in the market effectively. • Economies arise purely due to endogenous factors relating to efficiency of the entrepreneur or his managerial talents the marketing strategy adopted. • Basically, internal economies are those which are special to each firm. These solely depend on the size of firm and will be different for different firms.

§ § §

§ § §

1. Technical Economies Technical economies pertain not to the size of the firm but to the size of the factory. Technical economies are those which accrue to a firm from the use of better machines and techniques of production. As a result, production increases and cost per unit of production decreases. 2. Managerial Economies The advantages derived from the efficient management are called managerial economies. Usually efficiency of the management increases with an increase in the size of the firm. A large firm can divide its big departments into various sub-departments and each department such as finance, marketing, recruitment, training, finance, welfare, legal, administration , sales etc.

§ § §

§ § §

3. Labour Economies Under large scale production there will be scope for division of labour & specialisation. (skilled & unskilled labours) Expansion of the scale of production of the firm reduces the labour cost through proper division of labour. There will be overall development (both the efficiency & productivity of labour) which will result in reducing cost. 4. Financial Economies When compared to the smaller firms, longer funds are available to the large firms & hence they reap financial economies. They can borrow from banks or any other financial institution. They can also raise capital through the sale of shares & debentures to the public.

5. Marketing Economies

• Economies are achieved by a large firm both in buying raw-materials & also in selling its finished products. • A large firm can generally buy more cheaply than a small one, because it can purchase its raw-materials on a large scale at a low cost. • Similarly, on the sales side also, a big firm can reap advantages of large scale marketing. • Selling is generally less expensive per unit when large quantities are distributed, because a selling organisation should be an optimum size

§

§

§

§

6. Economies of R & D A large sized firm can spend more money on its research activities (R & D). They can spend hug sum money in order to innovate new varieties of products or improve the quality of the existing products. New innovations/new methods of producing a product may help to reduce its average cost. In cases of innovation it will become an asset of the firm.

§

§

§ §

§

7. Economies of welfare A large firm can provide welfare facilities to its employees such as subsidising housing, subsidised canteens, crèches for the infants of women workers, recreation facilities etc. All these measures have an indirect effect on increasing production & at reducing the cost. 8. Risk bearing Economies The big firms always involved risk-bearing. A big firm produces a large number of items and of different varieties so that the loss in one can be counter balanced by the gain in another. A large firm can avoid risk such as diversification of output,

External Economies

§ External economies refers to all those benefits which accrue to all the firms operating in a given industry. § External economies can be enjoyed by all the firms in the industry irrespective of their size. § The emergence of external economies is due to localisation. § According to Cairncross – “External economies are those benefits which are shared in by a number of firms/industries when the scale of production in any industry increases”.

External Economies

Economies of concentration

Economies of disintegration

Economies of information

§ §

§ § § §

1. Economies of Concentration When a number of firms are located in one place, all the member of firm reap some common economies. As the number of firms in an area increases each firm enjoys some benefits like, transport and communication, availability of raw-materials, research and invention etc. Financial assistance from banks and non-bank institutions easily accrue to firm. It is easy to make arrangements for repairs maintenance & special services required by an industry when the firm located. And even larger firms located in one particular locality not only increased quantity of goods & services but also reduced cost of production. Concentration of firms in a definite locality increases the competition among therein and

2. Economies of Information

§ When the number of firms in an industry expands they become mutually dependent on each other – they do not feel the need of independent research on individual basis. § The information regarding research & development, trading activities & other are information obtained from published in bulletins & journals. § Such information provides knowledge about modern development in business world, modern technology, inventions & innovations, market trends & the like. § It is easy to establish a common information bureau when the firms are concentrated in a locality. § Some times the government bears the cost of information & research services & benefits are shared by the industries.

3. Economies of Disintegration

• When the industry grows, it becomes possible to split up production into several processes & leave some of the processes to be carried out more efficiently by specialised firms. • This makes specialisation possible & profitable. For example – cotton Textile Industry – some firms may specialise in manufacturing thread, some others in producing dhoties, some in knitting banians some in weaving sarees etc. • The disintegration may be horizontal or vertical. Both will help the industry in avoiding duplication and saving time materials.

External Economies

§ External economies refers to all those benefits which accrue to all the firms operating in a given industry. § External economies can be enjoyed by all the firms in the industry irrespective of their size. § The emergence of external economies is due to localisation. § According to Cairncross – “External economies are those benefits which are shared in by a number of firms/industries when the scale of production in any industry increases”.

External Economies

Economies of concentration

Economies of disintegration

Economies of information

§ §

§ § § §

1. Economies of Concentration When a number of firms are located in one place, all the member of firm reap some common economies. As the number of firms in an area increases each firm enjoys some benefits like, transport and communication, availability of raw-materials, research and invention etc. Financial assistance from banks and non-bank institutions easily accrue to firm. It is easy to make arrangements for repairs maintenance & special services required by an industry when the firm located. And even larger firms located in one particular locality not only increased quantity of goods & services but also reduced cost of production. Concentration of firms in a definite locality increases the competition among therein and

2. Economies of Information

§ When the number of firms in an industry expands they become mutually dependent on each other – they do not feel the need of independent research on individual basis. § The information regarding research & development, trading activities & other are information obtained from published in bulletins & journals. § Such information provides knowledge about modern development in business world, modern technology, inventions & innovations, market trends & the like. § It is easy to establish a common information bureau when the firms are concentrated in a locality. § Some times the government bears the cost of information & research services & benefits are shared by the industries.

3. Economies of Disintegration

• When the industry grows, it becomes possible to split up production into several processes & leave some of the processes to be carried out more efficiently by specialised firms. • This makes specialisation possible & profitable. For example – cotton Textile Industry – some firms may specialise in manufacturing thread, some others in producing dhoties, some in knitting banians some in weaving sarees etc. • The disintegration may be horizontal or vertical. Both will help the industry in avoiding duplication and saving time materials.

Dis - economies of scale § Though there are a good number of advantages in the large scale production, it is not free from some limitation which is called diseconomies of scale. § Just like economies of scale diseconomies o scale are also classified into – internal and external diseconomies

Diseconomies of Scale

Internal Diseconomies

External Diseconomies

Internal Diseconomies of Scale
Difficulties of Management Problems of Co-ordination Increased Risks Labour diseconomies

Financial difficulties Marketing diseconomies

Scarcity of factor supplies

§ § § §

§ § §

1. Difficulties of Management As a firm expands, complexities & problems of management increases The entrepreneur & management will not be able to maintain contact with each other & check on all the department a very large concern. The problem of supervision will be there. For the defects in organisation will lead to wastes of resources & increasing average cost. 2. Problems of Co-ordination The task of organisation & co-ordination become more & more difficult with the increasing size of the firm. The management of the firm will gradually face numerous problems of decision-making & organisation. Decisions taken in a hurry result in inefficiency &

§

§

§ §

3. Increased risks As the scale of production increases, investment also increases, so too the risks of business. The large the output, obviously the greater will be the loss form an error of judgment or misfortune in business. 4. Labour diseconomies Labour diseconomies may also arise with the growing scale of output. It may result in lack of initiative & industrial disputes leading to increase in cost of production.

§ §

§

§

5. Financial difficulties A big concern needs huge capital which cannot always be easily obtained. Hence, the difficulty in obtaining sufficient capital frequently prevents the further expansion of such firms. 6. Marketing diseconomies When the industry expands & the firm grows, competition in the market tends to become stiff. Thus, firms under monopolistic competition will have to undertake extensive advertising & sales promotion efforts & expenditure which ultimately

§

§

§ § §

§

7. Scarcity of factor supplies Due to the increase in the concentration of firms in a particular locality, each firm will find it difficult to get factor supplies regularly & adequately. There will also be the problems of increased factor prices. 8. Over production There is every possibility in big business that production may exceed the requirements. This resulting in over production. It is very difficult to dispose off a large output profitably. 9. Difficulties in Decision – making A larger firm may find it very difficult to make a quick & correct decision.

External Diseconomies
Environmental Pollution

Resources get depleted

Increase price of factor inputs

Cost of living increases