In
the long run, a firm can change the amounts of all the factors of production
(both variable and fixed factors), that is, it can change the scale of
production. When a firm changes its scale of production it does not lead
to a proportionate changes in output. The table below shows the
proportionate change in output to an increase in the size by employing more of
all the factors of production.
According
to the above table the firm begins to increase in size by increasing all
its factors of production, its output increases more than
proportionately.[ 100% increase in factors leads to a 150% increase in
output; then a 50 % increase in factors leads to a 60% increase in
output.] A firm is said to be experiencing economies of scale, when the
percentage increase in the output is greater than the percentage increase in
the factors of production.
Therefore
the term economies of scale
refer to a situation where an increase in the size of the firm leads to a
falling average cost.
As
the firm continues to increase in the size by increasing all factors of
production, its output increases less than proportionality. [33⅓ % increase in
factors leads to a 25 % increase in output; then a 25 % increase in
factors leads to a 20% increase in output.] A firm is said to be
experiencing diseconomies of scale, when the percentage increase in the output
is less than the percentage increase in the factors of production.
The
relationship between Economies of scale and average cost is very important in
economics. The prices of land, labour and capital do not change, but
economies of scale result in lower
average costs. When the firm enjoys the economies of scale,
doubling of factor inputs (land, labour and capital), would result in a two and
a half times greater output. If other things do not change, its cost per unit
(average cost) must fall.
When
a firm achieves a size where it is producing at the lowest possible average
cost it is said to be at its optimum
size.
The
optimum size will very over time as technological progress change the
techniques of production.
In
addition to this, more loaded men and machinery leads to machine fault and
human failure cause breakdown of production. When the size increases
management becomes more complex and difficult. Managerial function of
co-ordination, consultation and interdepartmental decision making will get
delayed due to the size.
There
will be possibility of delay in implementation of decision within the
organization.
Delay
in communication will reduce the involvement of the employees.
Sorting
out and solving the problems of lack of identification and recognition which
reduce the commitment in long run.
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