Production Function
5.6. ECONOMIES TO SCALE
The benefits obtained by business firms as a result of large scale production are referred to as economies to scale. Large scale production may be the result of large plant size, increase in the scale of production. Thus in a broad sense, anything which serves to minimize average cost of production in the long run as the scale of output increases is referred to as 'economies of scale'. Economies arise purely due to endogenous factors relating to efficiency of the entrepreneur or his managerial skills or the marketing strategy adopted. The economies to scale may be broadly classified into 1. Internal economies. 2. External economies.
Internal Economies
Internal economies are those economies which are open to an individual firm when its size expands. They emerge within the firm itself as its scale of production increases. Internal economies solely belong to the individual firms when the firm increases its scale of production, dependent of the action of other firms. Internal economies are classified into:
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● Labour economies: Division of labour and specialization becomes advantageous to the producer when he is producing
on a large scale. Moreover a large firm attracts more efficient labour, as it can offer wide vertical mobility, prospects of promotion, as such the skill, efficiency and productivity of labour tend to grow leading to labour economies.
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● Technical economies: As a firm expands, it can use superior technique, capital goods, where as small firm cannot afford to install high quality machine. Increased use of machines leads to faster production, and better quality products.
Production can be put to the optimum level. Bigger firms engage in experiment and research leading to better products.
The expenditure on research may not have a bigger impact on the firm, but on the other hand a small firm cannot afford to make costly experiments. This can be because of the huge expenditure involved, and lack of qualified personnel to conduct the same.
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●● Economies of linked processes: A large plant usually enjoys the advantage of linking processes. This is done by arranging production activities in a continuous sequence without any loss of time. For example, in the printing press the editing and printing of the news is taken out in the same place, this is in order to avoid wastage of time. Large units of machines and their continuous running by a large firm are often more economical in their power consumption as compared to a small machine. A large firm can avoid waste of its materials, which it can economically use for manufacturing certain by-products.
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● Managerial Economies: Large scale production gives the benefit of managerial specialization by creating departments entrusting to each a particular work such as purchase, stores, selling etc. Further considerable savings could be had in the general expenses. The overhead charges do not increase in proportion to increase in the size of business.
A large firm will be in a better position to appoint a technical person who will be suitable and efficient in handling the production process. An entrepreneur can delegate his functions to trained and specialized personnel in his various departments.
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● Marketing Economies: A large firm can buy raw materials
at a cheaper cost since it would be buying a larger scale.
Further a big firm also employs experts to purchase the required raw material more economically and in time. A large firm employs various marketing strategies and sell its products well, than the small firm.
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●● Financial economies: Big farms are usually regarded less risky by investors, hence they may be willing to lend capital to such firms even at a lower rate of interest than to small firms. Big firms can easily raise their capital in the money market by issuing shares and debentures. The shares of a big concern number in lakhs but a small firm cannot hope to do so, because of its limited publicity.
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● Risk bearing economies: Since a large firm produces a large volume of output, it is in a position to bear the risks of losses and uncertainties. Since a large firm produces varied items, the loss in one of its products, can be compensated by the profit in the others. For instance in a restaurant, if the food items prepared are varied in nature, the demand would not exist for all the items at a time, if one of items are not demanded by the customers, the proprietor may face a loss, but if his size of operation is large the losses in one can be compensated by the other. In a large firm, there are less chances of disturbance as far as output of the product is concerned. The products on a large scale will have a wider market, thus the loss in one market can be compensated by the other.
External Economies
The benefits accruing to the industry as a whole because of its growth, the profit of which are shared by all the firms in the industry are called external economies. External economies are enjoyable by all the firms in the industry irrespective of their size.
Economies of localisation: When a number of firms are located in the same region, all of them tend to derive mutual benefits.
Concentration of a particular industry in one area, in course of time, results in the development of conditions helpful to the industry. For example: training of skill labour. Labourers drawn from different restaurants can be given a training, the benefits of
which can be obtained by all the restaurants who have sent their personnel for the training course.
Economies of information or market intelligence: When the firms expand their scale of operation, they indulge not only in increasing their production, but they also engage in research and development to further improve the product. The result of research is shared by all the firms in the industry, which improves their production and also profitability and also gain a better status over the other product competitors.
Economies of vertical integration: The growth of the industry will make it possible to split up production and the subsidiary jobs are efficiently done by specialized firms. For example: if the industry is engaged in ready made garments. The subsidiary work or the ancillary work like printing of the cloth or cutting of the cloth into different shapes and sizes is done only by those firms and the main job is done by the parent firm. This helps not only to increase production, but also saves time and provides employ- ment to other firms.
Diseconomies to scale: When the expansion of the production process takes place beyond a certain level, it results in diseconomies to scale. This diseconomies can result in increasing the average cost of production, complexities in managing huge work force, labour problems, difficulties in coordination, increased risks, scarcity of factor supplies, financial difficulties. These act as delimiting factors in bringing down the production level and hinder the growth of the firm.
A brief analysis of the above chapter on production explains the activity of converting the raw material into a finished product.
in the hotel industry also, this concept of conversion of input to output takes place in the form using various raw material to give the final product that is food. It thus becomes essential to understand the various concepts related the production function and its practical usuage in the production activity.
MODEL QUESTIONS Short Questions
1. What is production function?
2. Explain the main difference between 'fixed costs' and variable cost.
3. What are isoquant curves?
4. Explain the difference between short run and long run in the production process.
5. What are internal economies?
Essay Questions
1. Explain the law of variable proportions.
2. What is meant by economies to scale? Explain with suitable example.