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Long Run Production Function

The document discusses the concepts of external economies of scale, which benefit firms from industry growth, and diseconomies of scale, which increase production costs as firms expand. It outlines factors contributing to external economies, such as improved transport and education, and differentiates between internal and external diseconomies, highlighting issues like managerial inefficiency and increased costs from industry competition. Overall, it emphasizes the balance between the benefits of scaling up production and the potential drawbacks that can arise.

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15 views

Long Run Production Function

The document discusses the concepts of external economies of scale, which benefit firms from industry growth, and diseconomies of scale, which increase production costs as firms expand. It outlines factors contributing to external economies, such as improved transport and education, and differentiates between internal and external diseconomies, highlighting issues like managerial inefficiency and increased costs from industry competition. Overall, it emphasizes the balance between the benefits of scaling up production and the potential drawbacks that can arise.

Uploaded by

nhp9960
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Law of Returns to Scale

Long-run production Function


External economies of scale
• External economies of scale refer to the economies in production that
a firm achieves due to the growth of the overall industry in which the
firm operates.
• External economies of scale transpire outside a firm, within an
industry. Therefore, when an industry’s scope of operations expands,
external economies of scale are said to have been achieved.
For example, the creation of a better transportation network, which
results in a subsequent fall in the transportation cost of a firm operating
within that industry, leads to external economies of scale.

Factors of External Economies of Scale


• Improvement in transport and communication network
• Focus on training and education within the industry
• Support of other industries
What is Diseconomies of Scale?

Diseconomies of scale refer to the disadvantages that arise due


to the expansion of a firm’s capacity leading to a rise in the
average cost of production. Similar to the economies of scale,
diseconomies of scale can also be categorised into internal and
external diseconomies of scale.
There are two types of economies of scale:
1. Internal diseconomies
2. External diseconomies
Internal diseconomies
Internal diseconomies refer to the diseconomies that a firm incurs due to the
growth of the firm itself. These diseconomies of scale result in a decrease in
the firm’s output and increase in the long-run average cost.

• Managerial inefficiency: When a firm expands its production capacity, control


and planning also need to be increased. This requires the administration to be
more efficient. Often due to the challenge of managing a bigger firm,
managerial responsibilities are delegated to the lower level personnel. As these
personnel may lack the required experience to undertake the challenge, it may
result in low output at a higher cost.

• Labour inefficiency: When a firm expands its production capacity, work areas
may become more crowded leaving little space for each worker to work
efficiently.
External diseconomies
External diseconomies of scale refer to the disadvantages that arise
due to an increase in the number of firms in an industry-leading to
overproduction.
• An increase in the prices of raw materials consequently increasing
the cost of production in the industry.
• An increase in the wages of the skilled workers consequently
increasing the cost of production in the industry.
• Firms are bound to employ expensive waste disposal or recycling
methods, which increases the long-run cost of production.
• The concentration of firms within an industry may lead to excessive
need for advertising and promotion, consequently increasing the
cost of production in the industry.
Online Sources
• Consumer’s Equilibrium by Indifference Curve Analysis –
GeeksforGeeks (Consumer equilibrium)
• Economies And Diseconomies Of Scale | Types: Internal, Exter

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