GOOD AFTERNOON

PRODUCTION ANALYSIS (LR)

Long Run Production Function

This is also called as: Production Function with all variable inputs (or) LAW OF RETURNS TO SCALE. If all inputs are changed simultaneously, the concept of RETURNS TO SCALE is used to understand the behavior of output. In the long run, output can be increased by increasing the Scale of Operations (increasing all the factors at the same time and by the same proportion). The law that governs the scale of operations are called the LAW OF RETURNS TO SCALE. Symbolically, Q = f (L, N,K,------); Q=output; L=Land; N=Labor; K=Capital.

Economies of large scale production

There are two types of economies which affect the large scale production. Internal economies & internal diseconomies. External economies & external diseconomies. INTERNAL ECONOMIES arises from the growth of the firm. They are enjoyed by the firm only. EXTERNAL ECONOMIES arise from the growth of the industry. They are available to all the firms in the industry.

Internal Economies

Economies obtained by a firm from its own growth are called Internal Economies. Such as: Technical economies as the size of productive establishments increases, some mechanical advantages may be obtained-better process-automation-specialization from the division of labordepartmentalization, etc. Marketing economies This is related to buying and selling. Example: Big firms buy raw materials and fuel in bulk at lower prices concessions in transport organizations- have own sales man to do marketing-advertisements-publicity campaigns, etc. Financial economies Large and reputed firms can credit at minimum rates of interest get loans at lower rates of interest from banks and financial institutions- issue debentures to the public through stock exchange-low cost money. Risk-bearing economies - several kinds of products many markets diversified methods of production, etc.

External Economies
As the industry grows, external economies will also become available to all the firms in the industry. Such as: Supply of labor-skilled-training, etc. Supply of services neighborhood-components-raw materials-repairing services to main industry, etc. Ancillary industries which manufacture the finished/consumer goods making use of the industrial products-byproducts of the main industry, etc. Transport facilities roads, railways, communication facilities, etc. Banking services and market research credit institutions establish nearby for convenience, etc.

Internal and External Diseconomies

Internal Diseconomies: If grown beyond the capacity - non availability of bigger size or higher cost-division of labor only certain extent management problem beyond credit limits banking becomes costly, etc. External Diseconomies : Obstacles in growth high land cost- costly raw materials- scarcity of skilled labor, etc.

Returns to Scale (stages) are classified as:

A firm faces three stages of return to scale in long run PF: Increasing Returns to Scale (IRS): If output increase more than proportionate to the increase in all inputs. Constant Returns to Scale (CRS): If all inputs are increased by same proportion, output will also increase by the same proportion. Decreasing Returns to Scale (DRS): If increase in output is less than proportionate to the increase in all inputs.

Increasing Returns to Scale (IRS)

IRS is obtained when a given percentage increase in all inputs, leads to a higher percentage increase in the total output-(more than proportionately) If labor and capital are increased by 10% then the output increases more than proportionate above 10%. Diagram P11 Causes of IRS: Internal Economies:- size of capital good - fuller capacity of capital goods specialization of labor, etc. External Economies:- Sound financial sourcestechnical training institutes transport facilities - etc.

Constant Returns to Scale (CRS)

If all the factors of production are increased in a particular proportion and the output increases in exactly that proportion, the production function is said to be CRS. Diagram P12 If labor and capital are increased by 10% then the output also increases by 10%. Causes of CRS: Every operation has a limit. Beyond a point, there are internal and external economies which become diseconomies. CRS is a stage where internal and external economies are neutralized (No effect on the production increase)-The beginning stage of diseconomies. In mathematical language CRS is called as Linear production function.

Decreasing Returns to Scale (DRS)

If the factors of production are increased in a particular proportion and the output increases by less than that proportion than the production function is said to be DRS. When a business firm continues to expand even beyond the point of constant returns, a stage comes when diminishing returns to scale set in. When labor and capital are increased by 10% then the output increases less than proportionate to 10%. Diagram P13 Causes of DRS: Internal diseconomies:Management-corruption-unrest in departments-over utilization of machines-higher cost of production. External diseconomies:- Congestion of industrial areas, transport facilities, government freight charges which are high, price of raw materials-land rents, etc. A firm faces all the three stages in long run PF.

End Law of Returns to Scale

PPTs by Dr. Thirumagal Pillai