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Production Function
Laws of Production
Short run Laws of Production
Marginal Product
Illustration
Consider the Kitchen at Mels hot dogs, a restaurant that sells hot
dogs, French fries and soft drinks. Mels kitchen has one gas
range for cooking hot dogs, one deep fryer for cooking French
fries and one soft drink dispenser. One cook in the kitchen can
prepare 15 meals (consisting of a hot dog, fries and soft drink)
per hour. Two cooks can prepare 35 meals per hour. The marginal
product of the second cook is 20 meals per hour. Adding a third
cook results in 50 meals per hour being produced, so the marginal
product of third cook is 15 (= 50 35) additional meals per hour.
Contd..
Therefore, after the second cook, the marginal product of
additional cooks begins to decline. The fourth cook, for example
can increase the total number of meals to 60 per hour marginal
product of just 10 additional meals. A fifth cook adds only 5 extra
meals per hour, an increase to 65 meals. While the 3rd, 4th and 5th
cooks increase the total number of meals prepared each hour, the
marginal contribution is diminishing because the amount of space
and equipment in kitchen is fixed, (i.e. capital is fixed). Mel
could increase the size of the kitchen or add more cooking
equipment to increase the productivity of all workers.
TP
AP
MP
20
20
20
50
25
30
90
30
40
120
30
30
135
27
15
144
24
147
21
148
18.5
148
16.4
10
145
14.5
-1
Stages of Returns
Increasing Returns
Stage I
Decreasing Returns
Stage II
Negative Returns
Stage III
Contd..
Contd..
Economies of Scale
As a firm expands its scale of operations, its costs will fall due to
the benefits arising from expansion known as internal economies
of scale. These benefits can be assessed by looking at changes in
average costs at each stage of production as the firm moves into
long run.
By growing, a firm can expect to reduce its average costs and
become more competitive.
How does a firm expand? A firm can increase its scale of
operations in two ways.
Internal growth, also called organic growth
External growth, also called inorganic growth - by merging with
other firms, or by acquiring other firms
Diseconomies of Scale
It occurs primarily because as the scale of operations
increases it becomes even more difficult to mange the firm
effectively and coordinate the various operations and
divisions of the firm.
The number of meetings, paperwork and telephone bills
increase more than proportionately to the increase in scale of
operation and it becomes increasingly difficult for top
management to ensure that their directives and guidelines are
properly carried out by their subordinates.
Thus efficiency decreases and costs per unit tend to rise.
Types
of
diseconomy
scale
Example
of
Communication
Coordination
As a business grows control of activities gets harder
and
control As the firm gets bigger and new parts of the business are set up
problems
it is increasingly likely people will be working in different ways and
this leads to problems with monitoring
Motivation
Diseconomies of scale
Difficulties of management
Difficulties of coordination
Difficulties of Management
Increased Risks
Labor Diseconomies
Scarcity of Factor Supplies
Marketing Diseconomies
Illustration
Economies of scope
Cost savings when different goods/services are produced under one roof
Scope economies are cost advantages that stem from producing multiple
outputs
Big scope economies explain the popularity of multi-product firms.
Economies of scope exist when joint cost of producing two or more goods
is less than the separate costs of producing the goods. In case of two goods
X& Y ,
C(X,Y) < C(X) + C(Y)
Contd..
AC1
AC2
Quantity
Q
2Q
35
36
Cost Concepts
Social Costs
Social costs
Private costs
Replacement Cost
MC
TVC
TFC
Cost
Cost
ATC
AVC
AFC
Output
AC,MC
MC1
MC0
ATC1
ATC0
Output
TFC
TVC
TC
AFC
AVC
AC
MC
100
100
100
25
125
100
25
125
25
100
40
140
50
20
70
15
100
50
150
33.3
16.6
50
10
100
60
160
25
15
40
10
100
80
180
20
16
36
20
100
110
210
16.3
18.3
35
30
100
150
250
14.2
21.4
35.7
40
100
300
400
12.5
37.5
50
150
100
500
600
11.1
55.6
66.7
200
100
500
200
640
300
720
400
740
500
800
600
900
TFC
20
TVC
TC
30
45
70
95
150
220
MC
AC
Sum
Suppose Marutis total cost of producing 5 cars
is 10.5 lakhs and its total cost of producing 6
cars is 12 lakhs, what is average cost of
producing six cars? What is marginal cost of
sixth car?
In reality, cost curves are closer to L-shaped curves that to Ushaped curves
Returns to scale vary considerably across firms and industries.
Other things being equal, the greater the returns to scale, the
larger the firms in an industry are likely to be. Because
manufacturing involves large investments in capital equipment,
manufacturing industries are more likely to have increasing
returns to scale than service oriented industries. Services are
more labour intensive
58
Fixed Costs
59
Organic strategies
Concentric Diversification
Concentric Diversification
Conglomerate Diversification
Conglomerate diversification
Diversification: Vertical
Backward Integration
Forward Integration
Diversification: Horizontal
Global sourcing
Global sourcing
Thank you