the law of diminishing returns * economies & diseconomies of scale
...s labour. Increasing labour allows for increased specialisation of labour which increases efficiency & therefore also increases productivity. This allows for more physical product [TPP] to be produced. This increases a firm’s profit. This trend then slows as it enters the second phase. The TPP and the MPP continue to increase, but at a slower rate than before. This means less profit for the business than before. If the variable factor continues to increase, the curve will enter the third phase. This is when the TPP and the MPP decrease. The MPP decreases below zero. This means that the firm is experiencing a loss in profit, as production costs are too high & not enough product is being produced to cover these costs. This can be attributed to inefficiency and a lack of productivity. In order to prevent a loss of profit, but enable some lowering of the costs of production, a firm will change all it’s factors of production to find the most suitable combination. When all factors can be changed the firm enters the period known as the long run. In the long run, when a firm expands its scale of operation, it increases its output. This lets the firm have greater efficiency & productivity and therefore decreases its production costs. This concept that a firm needs to increase production in order to minimise costs and maximise profits is known as “internal economies of scale”. The causes of internal economies of scale are those which can be controlled by the firm itself. An example of one cause is that a larger firm will be able to invest more money into better capital which is more efficient. Also, a large firm can put more money and resources into research & product development. This can find new ways of doing things or diversify the firm’s production so as to make more money. Another way internal economies of scale are achieved is by putting money into training for employees. This raises the skill level of the labour, making production more efficient as people are better at their jobs. Also, larger firms can buy raw materials in bulk and save money that way. All these examples cause greater efficiency and demonstrate the principle of internal economies of scales. However, when a firm continues to expand, inefficiency will arise and the costs of production will eventually increase instead of decreasing. This concept is known as “internal diseconomies of scale”, and can be viewed as a reverse-situation of economies of scale. The causes of internal diseconomies of scale are circumstances which a firm can control. They occur because of disadvantages associated with the company being too big. An example is that when a firm is very large, management becomes inefficient because it loses touch with the day-to-day running of the firm. Another cause can be duplication and excessive paperwork. This requires a large expense for administration, and also reduces productivity. Another problem with large firms is that management and employers do not know the staff personally. This can make it harder to settle workplace disputes, or to keep employees happy because problems often go unnoticed until they escalate and perhaps unions are involved. All these situations cause inefficiency and demonstrate the concept of internal diseconomies of scale. As discussed, internal economies of scale are experienced when an expanding firm’s production costs decrease & it’s profits increase. However, this will come to a point where the expansion will turn into internal diseconomies of scale, which is when production costs increase. This can be represented graphically by the Long Run Average Cost Curve. [see below] As shown in the diagram, economies of scale advantage an expanding firm to a point known as the technical optimum. At this point, the continuing expansion of a firm will result in diseconomies of scale being created. These disadvantage a firm and increase it’s production costs. There is one way the curve can be shifted downwards. This occurs through “learning by doing”. [see diagram below] This is when a firm’s expansion allows it to become more efficient because of repeating the production, and becoming better at it. An example is a company which delivers it’s products. By learning to transport it’s products via the highways instead of main streets, the firm can decrease the amount of time an employee spends in traffic. This means that more deliveries can be made in the same amount of time. This increases productivity and decreases production costs. The shift occurs for t...