Scale of Production

Scale of production
The term scale of production means the size or the volume of the production in the
firm. The actual scale of production of a firm is determined by technological as
well as market forces. The importance of technology in determining the scale of
production is easily understood. For instance , in a modern oil refinery, a large no.
of complex machines have to be used. These involves a huge amount of capital
expenditure. Such a large investment doesn’t become profitable unless volume of
production is too large. Thus, the nature of technology sometimes dictates large-
scale production. On the other hand, it may permit small- scale production in some
areas.
The importance of the market is also emphasized in this connection. A commodity

which is in great demand in the market will be produced in large quantities.
Of course, this doesn’t necessarily imply large- scale production because there can
be many small firms, each producing on a small- scale, but together producing a
large total amount of the commodity.
Internal and external economies of scale
When the scale of production increases, the producer reaps some benefits. these
benefits reduces their average cost of production. These are called as Economies of
scale. Economies of scale are of two types:_
1) Internal Economies of Scale:
Definition and Types:
Internal economies of scale are those economies which are internal to the firm.
These arise within the firm as a result of increasing the scale of output of the firm.
A firm secures these economies from the growth of the firm independently. The
main internal economies are grouped under the following heads:

(i) Technical Economies: When production is carried on a large scale, a firm can
afford to install up to date and costly machinery and can have its own repairing
arrangements. As the cost of machinery will be spread over a very large volume of
output, the cost of production per unit will therefore, be low.
A large establishment can utilize its by products. This will further enable the firm
to lower the price per unit of the main product. A large firm can also secure the
services of experienced entrepreneurs and workers which a small firm cannot
afford. In a large establishment there is much scope for specialization of work, so
the division of labor can be easily secured.

(ii) Managerial Economies: When production is carried on a large scale, the task

of manager can be split up into different departments and each department can be
placed under the supervision of a specialist of that branch. The difficult task can be
taken up by the entrepreneur himself. Due to this functional specialization, the total
return can be increased at a lower cost.
(iii) Marketing Economies: Marketing economies refer to those economies which

a firm can secure from the purchase or sale of the commodities. A large
establishment is in a better position to buy the raw material at a cheaper rate
because it can buy that commodity on a large scale. At the time of selling the
produced goods, the firm can secure better rates by effectively advertising in the
newspapers, journals and radio, etc.
(iv) Financial Economies: Financial economies arise from the fact that a big
establishment can raise loans at a lower rate of interest than a small establishment
which enjoys little reputation in the capital market.

(v) Risk Bearing Economies: A big firm can undertake risk bearing economies by
spreading the risk. In certain cases the risk is eliminated altogether. A big
establishment produces a variety of goods in order to cater the needs of different
tastes of people. If the demand for a certain type of commodities slackens, it is
counter balanced by the increase in demand of the other type of commodities
produced by the firm.
(vi) Economies of Scale: As a firm grows in size, it is-possible for it to reduce its
cost. The reduction in costs, as a result of increasing production is called
economies of scale. The economies of scale are obtained by the firm up to the
lowest point on the firms long run average cost curve. The main sources of
economies of scale are in brief as under.:

Diseconomies of Scale:
Definition:

The extensive use of machinery, division of labor, increased specialization and

larger plant size etc., no doubt entail lower cost per unit of output but the fall in
cost per unit is up to a certain limit. As the firm goes beyond the optimum size, the
efficiency of the firm begins to decline. The average cost of production begins to
rise.
Factors of Diseconomies:
The main factors causing diseconomies of scale and eventually leading to higher

per units cost are as follows:

(i) Lack of co-ordination. As a firm becomes large scale producer, it

faces difficulty in coordinating the various departments of production. The lack of
co-ordination in the production, planning, marketing personnel, account, etc.,
lowers efficiency of the factors of production. The average cost of production
begins to rise.

(ii) Loose control. As the size of plant increases, the management loses control
over the productive activities. The misuse of delegation of authority, the redtapisim
bring diseconomies and lead to higher average cost of production.
(iii) Lack of proper communication. The lack of proper communication between

top management and the supervisory staff and little feed back from subordinate
staff causes diseconomies of scale and results in the average cost to go
up.
(iv) Lack of identification. In a large organizational structure, there is no close

liaison between the top management and the thousands of workers employed in the
firm. The lack of identification of interest with the firm results in the per unit cost
to go up.
(2) External Economies of Scale:
Definition and Types:
External economies of scale are those economies which are not specially availed
of by .any firm. Rather these accrue to all the firms in an industry as the industry
expands. The main external economies are as under:
(i) Economies of localization. When an industry is concentrated in a particular

area, all the firms situated in that locality avail of some common economies such
as (a) skilled labor, (b) transportation facilities, (c) post and telegraph facilities, (d)
banking and insurance facilities etc.
(ii) Economies of vertical disintegration. The vertical disintegration implies the

splitting up the production process in such a manner that some Job are assigned to
specialized firms. For example, when an industry expands, the repair work of the
various parts of the machinery is taken up by the various firms specialists in
repairs.
(iii) Economies of information. As the industry expands it can set up research

institutes. The research institutes provide market information, technical
information etc for the benefit of alt the firms in the industry.
(iv) Economies of by products. All the firms can lower the costs of production by
making use of waste materials.

External Diseconomies:
Definition:
A firm or an industry cannot avail of economies for an indefinite period of time.

With the expansion and growth of an industry, certain disadvantage also begin to
arise. The diseconomies of large scale production are:
(i) Diseconomies of pollution, (ii) Excessive pressure on transport facilities, (iii)

Rise in the prices of the factors of production, (iv) Scarcity of funds, (v) Marketing
problems of the products, (iv) Increase in risks.

Internal and External Economies Of scale:
When an increase in the scale of production results in a more than proportionate
increase in output the firm is said to be experiencing economies of scale.

There are two types of Economies of scale

Internal Economies of scale
External Economies of scale
Internal Economies of scale are those which arise from the growth of the firm
independently of what is happening to the other firms. They simply arise from an
increase in the scale of production in the firm itself. A firm may grow as a result of
increasing the number of workplaces it has or increase the size of its plants.

External Economies of scale are those advantages in the form of lower average
costs which a firm gains from the growth of the industry. These economies are
available to all the firms in the industry independently of change in the scales of
their individual output.

Internal economies of scale can be divided into technical economies, marketing
economies, financial economies, research and development economies, managerial
economies and risk bearing economies.

External Economies of scale are especially significant when industries are heavily
localized in industrial clusters. Example of economies of scale includes labor,
ancillary services, disintegration, cooperation, commercial facilities and
specialized market.

Internal and External Diseconomies Of scale:
When an increase in the scale of production results in a less than proportionate
increase in output the firm is said to be experiencing diseconomies of scale

There are also two types of diseconomies of scale

Internal Diseconomies of scale
External Diseconomies of scale

Internal diseconomies of scale occur when the firm grows beyond its optimum
size, efficiency declines and average cost begin to rise. The main problems which
arise when a firm grows too large are thought to be mainly attributable to
management difficulties. As the size of the firm increases, management becomes
more and more complex. It becomes increasingly difficult to carry out the
management function of coordination, control, communication and to maintain
good industrial relations.

External diseconomies of scale are when a firm experience disadvantage as a
result of the industry to which it belongs becoming too large. For example shortage
of labor with the appropriate skills, increasing demand for raw material may also
bid up the prices and cause cost to rise; land for expansion will become
increasingly scare and hence more expensive both to purchase and to rent.
Transport cost may also rise because of increased congestion. All firms in the
industry whether they are seeking to expand or not, may suffer rising cost as a
result of the industry getting large too quickly.
 RETURNS TO SCALE
 Reasons for Increasing Returns to Scale
Indivisibility- means that certain factors are available only in some minimum sizes. Certain
inputs particularly machinery, management etc are available in large and lumpy units. Such
inputs cannot be divided into small sizes to suit the scale of production. For example the cannot
be half machinery or half manager. Such inputs have to be employed even if production is small.
Therefore as the scale of production increases, these indivisible factors are utilized better and
more efficiently. This leads to increasing returns to scale.
Greater specialization- Another cause is greater degree of specialization of labour and

machinery .as the scale of production increases, the efficiency of the labour increases due to
division and specialization of labour.similary as the scale of production increases it becomes
possible to use specialized machinery and services of specialized and expert management. This
results in increasing productivity of inputs leading to increasing returns to scale.
 Causes for decreasing returns to scale

Complexity in management-increasing returns to scale beyond a point may create the problem
of proper management, leading to decrease in managerial efficiency. Large scale of production
creates the problem of lack of proper coordination, large bureaucracy, and lengthy chain of
communication between top management and the men in production line. As a consequences of
all this, the overall efficiency decreases.
Entrepreneur is a fixed factor- According to some economists decreasing returns to scale

arises because entrepreneur is an indivisible factor. An increase in scale may come to a point
where the abilities and skills may be fully utilized.
 REASONS FOR RETURNS O FACTOR
 Causes for Increasing Returns
1. Optimum utilization of fixed factors-there is always an optimum combination of variable

factors with fixed factors and return to any variable factor will not be optimum unless factor
combination is optimum. Therefore initially, when variable factor units improves the system and
total output increases at an increasing rate.
2. Division of labour (factor units) increases efficiency – when more and more units of variable
factors are applied, it leads to increase in efficiency of factors.eg. if variable factor is labour,
more and more units of labour will lead to division of labour which in turn increases efficiency.
 Causes of Diminishing Returns
1. Disturbance in optimum combination of factors- if variable factor is further increased; the
system again deteriorates and returns to the factor starts diminishing.
2. Factors of productions are not perfect substitute of each other- if the factors of production
are perfect substitute for each other, any factor , including the variable factor , could be applied
to any extent. In that case beyond a needed limit, it would have worked for other factors. But the
factors are not perfect substitute and so the applications of any factor beyond desired limit
becomes not of much use and it gets diminishing returns.
 Causes of negative returns
1. Overcrowding- if the firm keeps on increasing the variable factors even after getting
diminishing returns , there is overcrowding of variable factors (labour) resulting in lower
availability of tool per labourer. This reduces the efficiency of the labour and hence return to
additional worker becomes negative.
2. Mismanagement- continuous increase in variable factors on a given amount of fixed factor
creates the problem of mismanagement in the whole system. The additional unit of variable
factor may become uncontrollable and unmanageable. This results in loss of efficiency and
negative returns.

Scale of Production

Uploaded by

Copyright:

Available Formats

Scale of Production

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Scale of Production

Uploaded by

Copyright:

Available Formats

Scale of production

The importance of the market is also emphasized in this connection. A commodity

Internal and external economies of scale

Definition and Types:

(ii) Managerial Economies: When production is carried on a large scale, the task

(iii) Marketing Economies: Marketing economies refer to those economies which

The extensive use of machinery, division of labor, increased specialization and

The main factors causing diseconomies of scale and eventually leading to higher

(i) Lack of co-ordination. As a firm becomes large scale producer, it

(iii) Lack of proper communication. The lack of proper communication between

(iv) Lack of identification. In a large organizational structure, there is no close

(2) External Economies of Scale:

Definition and Types:

(i) Economies of localization. When an industry is concentrated in a particular

(ii) Economies of vertical disintegration. The vertical disintegration implies the

(iii) Economies of information. As the industry expands it can set up research

A firm or an industry cannot avail of economies for an indefinite period of time.

(i) Diseconomies of pollution, (ii) Excessive pressure on transport facilities, (iii)

 RETURNS TO SCALE

 Reasons for Increasing Returns to Scale

Greater specialization- Another cause is greater degree of specialization of labour and

 Causes for decreasing returns to scale

Entrepreneur is a fixed factor- According to some economists decreasing returns to scale

 REASONS FOR RETURNS O FACTOR

 Causes for Increasing Returns

1. Optimum utilization of fixed factors-there is always an optimum combination of variable

 Causes of Diminishing Returns

 Causes of negative returns

You might also like