1. Lecture 6
Scale of Production

2. Scale of Production
• The scale of production has an important bearing
on the cost of production
• It is the manufacturers common experience that
larger 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 benefit
from resulting economies of scale
• These economies are of two types
– External economies
– Internal economies

3. 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

4. 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 are
ignored
• 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 to
international 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

5. Types of Economies
• Internal Economies
• External Economies

6. Internal Economies
• Internal Economies are those economies in
production 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 a
result of its own expansion independent of the
size and expansion of the industry
• Internal economies may be of the following types
– Technical economies
– Managerial economies
– Commercial economies
– Financial economies
– Risk-bearing economies

7. Technical Economies
• There are four ways in which technical
economies 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

8. 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

9. Commercial Economies
• They arise from the purchase of materials and
sale of goods
– Large businesses have bargaining advantages and
are accorded a preferential treatment by the firms
they deal with
• They are able to secure freight concessions from
railway and road tranport
• Cheap credit from banks
• Prompt delivery
• Careful attention

10. Financial Economies
• These economies arise form the fact that a big
firm has better credit and can borrow on more
favourable terms.

11. 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

12. External Economies
• External economies are those economies which
accrue to each member firm as a result of the
expansion of the industry as a whole
• Expansion of an industry may lead to the
availability of new and cheaper raw
materials, tools and machinery and discovery and
diffusion of a superior technical knowledge
• There are various types of external economies
– Economies of concentration
– Economies of information
– Economies of disintegration

13. 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

14. 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

15. Economies of Disintegration
• When an industry grows, it becomes possible
to split some of the processes which are taken
over by specialist firms

16. Relationship between IE and EE
• No hard and fast line can be drawn between the two
• Internal economies are the result of expansion of
individual 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 an
industry
• If scale of production is increased it brings in
economies of scale. However, if it is increased beyond
limits the economies of scale would be converted in
diseconomies of scale

17. Production Possibility Curve
&
Production Function

18. Production Possibility Curve
• The production possibility curve shows the
maximum out put of any one commodity that
the economy can produce together with the
prescribed quantities of other commodities
produced and resources utilized
• In short, the production possibility curve tells
us what assortment of goods and services the
economy can produce with the resources and
techniques at its disposal

19. Example
Production Possibilities Goo1d X Good Y
(thousands) (thousands)
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0

20. Production Possibility Curve
• A curve depicting all maximum output possibilities for two or more
goods given a set of inputs (resources, labor, etc.). The PPF assumes
that all inputs are used efficiently
• At point X resources are not being efficiently utilized
• Point Y is not reachable under given resources

21. Marginal Rate of Transformation
• In order to produce more X we must sacrifice
some 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 and
more . That is why the production possibility
curve is concave

22. Iso-Revenue Line
• The iso-revenue line is the bundles of outputs
that return the same level of revenue.
– It represents the rate at which the market is
willing to exchange one product for another.

23. 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 firm’s organization
– Relative prices of the factors of production and the manner in which these
factors 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

24. 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 the
factors of production
• The combination of inputs depends on
technology
• Variability of the factors of production is
considered while defining production function

25. 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

26. Quiz
• What an indifference curve shows and why it
is convex to the origin?
• Show Income Effect, Price Effect and
Substitution Effect through indifference curve
analysis and explain it?
• What is elasticity of demand? Please Explain
different cases and types of elasticity of
demand.