BCom 1st Year Scale of Production Notes Study Material
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BCom 1st Year Scale of Production Notes Study Material
Many types of firms-small, medium and big-are engaged in production. Accordingly, there are sole proprietorship businesses with very little capital carrying on production on a small-scale, medium-sized partnership and very large limited companies with thousands and lakhs of shareholders and issued capital of several crores of rupees. Similarly, an industry may be large or small depending on the number and size of firms in it.
The Motive for Expansion
Every producer is guided by the motive to maximise his profits. In order to achieve this aim, he will adopt a form of production in which his cost of production is the lowest. If production on a large-scale offers many types of economic advantages leading to the reduction in costs, the producer will opt for large-scale production.
One of the main features of industrial development during the last two centuries has been the increasing size of business unit. The growth of largescale production has been due mainly to the following factors:
(i) specialization or division of labour;
(ii) revolution in the means of transport;
(iii) development of joint-stock companies;
(iv) increase in demand due to the rise in per capita income, etc.
Advantages of Large-scale Production
The above have made production possible on a large-scale. “The advantages of production on a large-scale”, says Marshall, “are best shown in manufacture; under which head we may include all businesses engaged in working up material into forms in which it will be adapted for sale in distant markets. The characteristic of manufacturing industries which makes them offer generally the best illustration of the advantages of production on a large-scale, is their power of choosing freely the locality in which they will do their work.”
Another characteristic of manufacture is that here machine and not hand work is most prominent. Manufacturing industries can be located in any regions determined by the manufacturers on certain considerations. As against this, agriculture and mining and quarrying, etc., can be established in places determined by nature.
The main advantages of production on a large-scale are economy of skin economy of machinery and economy of materials. They are generally analver under the title of economies of large-scale production or, simply, economies. scale. These are reductions in the average cost of a product in the long-run resulting from an expanded level of output. In other words, expansion of this scale of productive capacity of a firm or industry causes total production costa to increase less than proportionately with output. So long-run average costs of production fall.
Economies of scale are generally classified as:
(1) Internal economies; and
(2) External economies.
(1) Internal Economies
These economies arise from the expansion of the individual firm, inde pendently of changes in size of the other firms in the industry. They may be technological, managerial, financial or risk-spreading as analysed below:
(i) Economies in the Use of Factors of Production: In order to produce a large output at a lower average cost (cost per unit) than a smaller output means that the total cost of production must increase less than proportionately to output. If a small firm decides to double its output, it will not be necessary to build a new factory of the double size, double raw materials and double labour.
Doubling the length and breadth of a piece of land will lead to a four-fold increase in its area (20′ x 20′ = 400 sq. ft. but 40′ x 40′ = 1,600 sq. ft.). It will not be necessary to double the labour force as well, for greater division of labour will probably be introduced, so that average product of labour can be expected to increase. Further, a large firm is in a position to employ more efficient labour and more specialized machinery. A large undertaking makes bulk purchases of raw materials at a cheaper rate.
(ii) Economies in Management: The advantages of division of labour are not confined to the sphere of technical methods of production, they appear in the management of large firm. In a small firm the manager has many different functions to perform. Few people possess all the virtues necessary to perform all these functions. A large firm divides the functions of management into many parts and puts each in the hands of specialists.
“The gains from this elaborate division of labour are of two kinds. In the first place special abilities can be used to the full……….. Secondly, the man who is allowed to become a specialist is able to increase his knowledge of the particular task which is assigned to him.”
(iii) Marketing Economies: These are economies in large-scale buying and selling. The large firm can buy large amounts of raw materials as a single order. The firm that produces the raw materials can increase its output of the particular material required and can afford to sell it more cheaply. There is a further advantage to a large buyer. Because it is large, it can afford expert buyers, backed up by all the resources of scientific knowledge and equipment.
For large-scale selling a large firm has certain advantages. Where a large number of sales have to be made, and the sales costs are responsible for a large proportion of the final price, there will be considerable gain if the quantity of goods to be sold is large. Travellers and salesmen will be able to work near to their full capacity, and their capacity for making sales is enormous.
(iv) Economies of Finance: The large firm often has an advantage over the small concern on the financial side. Many firms borrow their working capital from the banks. In the absence of a standard lending rate, the banks charge the rate of interest depending on the standing of the borrower, the security offered, the amount borrowed, the purpose of the loan and the bank’s estimate of the risk involved. Large firms are considered to be safer borrowers. Larger firms are charged lower rates of interest, while smaller firms are charged higher rates. Thus large firms reap economies of finance.
(v) Economies of Research: For most industries, research has assumed great importance. In this matter too large concerns have advantage over small ones. A large firm can have its own laboratories and employ a large number of trained research workers. Any discoveries made by them become the property of their employers.
(vi) Economies in Welfare Measures: The efficiency of the workers can be increased by improving the conditions under which they work and by the provision of canteens and other welfare facilities. Large firms are in a better position to provide them. For the small concerns, the expenses will be too heavy.
(2) External Economies
These arise from the expansion of the industry which reduces the costs of all firms in the industry. They arise from the fact that most of the firms comprising the industry are concentrated in one area. Economies arising from localisation of industry are known as external economies. Such economies result in a fall in costs of each individual firm. The following are the chief external economies of scale: .
(i) Pecuniary Economies or Savings in Money Outlays: Technological conditions remaining unchanged, external economies offer pecuniary economies. Take an example; suppose the expansion of the whole industry leads to a significant increase in the demand for a particular component. Its production on a large-scale would generate internal economies and its price would fall.
(ii) Technological economies Result from Increased Technological Efficiency, Improvement in Quality of Inputs, etc.: The effect of external economies of scale is to shift the whole long-run average cost curve of the firm downwards. It means that the long-run average cost of each firm is less at every level of output.
Limits to Large-scale Production
(i) Specialization and standardisation of the work of men and machines (i.e., making industrial operations as uniform as possible and reducing them as Tar as possible to routine) have led to a tendency for production to be conducted on an ever larger and larger scale. But this development is conditional on the growth of communications and the widening of the markets. Large-scale Production is on the whole general throughout industry, but it operates with very different force in different trades.
The great size of the typical modern firm, however, cannot be explained or chiefly by reference to the advantages in the specialization of machinery and manual labour The broad advantages of division of labour apply at least as forcibly to labour with the mind as to labour with the hands. The elaborate on of brain work is a powerful force operating on the side of the large firm tends to increase the average size of firms. The small firm that has to supervise his own workmen, to do his own buying and selling, to keep his own unts, etc. is at a great disadvantage compared with the large firm.
The large firm segregates problems of technique from the problem of finance, deals in large figures with buyers and sellers and transport agencies and banks and is free to shake one’s wings and scan wide horizons and harbour deep designs.”
These are mighty weapons leading to the establishment of large firms. “It is the economies of large-scale government rather than of large-scale technique which dictate the size of modern business unit.” In other words, it is difficulties not of technique but of control which limit the growth of firms.
As Robertson points out, “There is no substitute for the ubiquitous eye of the small master, his first-hand acquaintance with details, his direct touch with employee and customer.” The battle between the large firm and the small is never fought to a definite finish. Small firms persist even today. “But on the whole in the modern world the race is to the swift, and the battle to the strong.”
(ii) Though expansion of the scale of production produces economies of scale, firms do not go on expanding indefinitely. After a point, expansion leads to diseconomies of scale and there takes place an increase in the long-run average costs of production. Both internal diseconomies and external diseconomies may begin to operate.
The main sources for the appearance of internal diseconomies are:
- possibility of increased administrative costs per unit of output arising from the increased problems of coordinating activities on a larger scale
- lengthening of the management hierarchy and growth of bureaucracy.
External diseconomies arise from increases in prices of inputs caused by expansion in demand of firms which use them (i.e., pecuniary diseconomies) and from transport and communication bottle necks, etc. (i.e. technological diseconomies).
(iii) As the scale of production increases, the risks of production also increase. The greater the output, the greater, therefore, will be the loss from an error of judgment. Unwillingness to bear greater risks may be another limitation on the growth of firms as producers are generally risk-averse.
Disadvantages of Large-scale Production
Large firms suffer from the following chief disadvantages:
(i) Sluggish Response to Changes: Whatever the importance of a decision, a one-man business has to take it and alone is responsible for it. He is, therefore, likely to be quick in taking the decision as he is not required to consult anybody else. In a large firm, the situation is different. Minor matters are left to the subordinate staff, while important questions go to the superiors, such as to manager who before deciding has to convince the board of directors about the soundness and correctness of the decision. Thus there is no immediate response to any issue or problem.
(ii) Bureaucratic Control: The larger the firm, the more bureaucratic its organisation tends to be. Its management becomes quite impersonal. It has to observe many rules and regulations before taking any decision. Red tapism is very likely to crop up.
(iii) Loss of the Motive of Self-Interest: The interest of the sole proprietor and that of the firm coincide. So there is less waste and greater efficiency.
Though the interests of the managers of a large firm are bound up with those of the company that employ them, the coincidence is not that robust.
The Survival of the Small Firm
“The growth in the size of the firm has not prevented the survival of the mall firm, in spite of the fact that, though there are some disadvantages of large size, these are more than counterbalanced by the advantages of large-scale production.”
What Hanson means is that advantages of large-scale production far outweigh its disadvantages and yet small firms have survived. It needs to be explained.
In this context Marshall says that “The small employer has advantages of his own. The master’s eye is everywhere; there is no shirking by his foremen or workmen, no divided responsibility, no sending half-understood messages backwards and forwards from one department to another. He saves much of the book-keeping, and nearly all of the cumbrous system of checks that are necessary in the business of a large firm; and the gain from this source is of very great importance in trades which use the more valuable metals and the expensive materials.”
The following are the main reasons for the survival of small firms:
(i) In the case of direct services the size of the business unit tends to be small. Examples are the services of doctors, lawyers, accountants, tailors, electricians, domestic plumbers, etc.
(ii) In retail businesses, the size is small. It has been so inspite of the competition of supermarkets, multiple shops, cooperative societies, departmental stores, skyshops, etc. The reason for the survival of small retailers is that they give personal attention to the particular requirements of their customers.
(iii) Large-scale production requires a large market for the product. Where there is limited demand for a commodity, small firm is the requirement.
(iv) When customers prefer varieties and dislike standardised products, small firms are the answer.
(v) It may be that in some forms of production, costs quickly begin to rise as production expands. Here the economical unit is the small firm.
(vi) It is true that small firms are at a great disadvantage in getting information and in making experiments. But in these days instant communications, newspapers, trade and technical publications of all kinds, television, computer and inter-net services, etc. bring much of the information and knowledge these firms want. The secrecy of business is on the whole diminishing.
So although the small firm “can seldom be in the front of the race of progress, he need not be far from it, if he has the time and the ability for availing himself of the modern facilities for obtaining knowledge.”