Scale and resource mix Learning Objectives Understand what is meant by productive efficiency Learning Outcomes  Describe the issues involved in choosing the right scale of production - E  Explain what Economies of scale and Diseconomies of scale are - C  Analyse the benefits and drawbacks of labour and capital intensive production strategies - A

Introduction to scale Scale of production refers to a firms output levels, this will depend on its capacity. Capacity is the maximum output that an organisation can produce at any moment, given its resources. Question – what will the capacity depend on?

Capacity will depend on… Its capital – office space, machinery, equipment etc. The existing level of technology The number and skills of employees. If a business increases its capacity it is increasing the scale of production. Deciding of the correct scale of capacity is critical. If the capacity is to low, they will have to turn away orders, possibly losing customers. If the level is to high, they will have idle resources. Question - What will the right scale depend on?

The right scale depends on… The expected levels of sales The costs involved in growing The resources available How can a firm increase its scale?

A firm can increase its scale by… Investing in new capital such as IT systems, equipment and technology Investing in labour – training, hiring more employees Taking over another business As a business grows and changes its scale it tends to experience efficiency gains up to a certain scale and then inefficiencies after that.

Scale of business Large scale businesses use more resources and produce more output They have higher turnover, lower unit costs and generally make higher profits Thus, there are strong motives for increasing the scale of production

Productive Efficiency Exists when production is achieved at lowest cost There is productive inefficiency when the cost of production is above the minimum possible Eg a firm which produces 1,000,000 units at a cost of £10,000 would be productively inefficient if it could have produced that output at a cost of £8,000

Why might a business be productively inefficient? Complete the worksheet - Why might a business be productively inefficient? Ext – Can you think of any real businesses which could be productively inefficient?

Economies and Diseconomies of Scale Economies of scale lead to lower average costs May underlie the development of monopolies Diseconomies of scale may lead to higher average costs Diseconomies of scale may discourage the growth of firms

The firm’s average costs of production initially fall as output increases At Q2, average total costs are at their lowest level (cost- minimising level of output / optimum level of output) Beyond this level of production, average costs rise Productive efficiency Productive inefficiency Falling average costs Rising average costs

Efficiency and economies of scale Productive efficiency is linked to ECONOMIES and DISECONOMIES of scale When firms increase the scale of their production, their average costs change

Example… For example: a specialist car manufacturer produces 2,000 cars a year on average costing £50,000 each to make. If production increases to 2,000,000 a year, the average cost of production may fall to £15,000.

Review Questions What does capacity depend on? Why might a business be productively inefficient? What are economies and diseconomies of scale?

Starter questions What are economies and diseconomies of scale?

Economies and Diseconomies of Scale When average costs fall as the scale of production increases, economies of scale exist. BUT If average costs rise when the scale of production rises, then there are diseconomies of scale

Internal Economies of Scale Occur when a firm grows and changes its scale and size  Purchasing economies  Marketing economies  Technical economies  Specialisation and Managerial economies  Financial economies  Risk bearing economies Task What are they? How do they work? Ext – Why do economies of scale matter?

External Economies of Scale The reduction in cost which any business in an industry might enjoy when the industry or market grows May be as a result of cluster effects (many firms in the same industry located close to each other, providing markets, sources of supply and a pool of trained labour) In some areas, a whole industry has developed, like the car industry in the West Midlands. This concentration means that firms there can share expertise and training. They may even work on new research together. This can lead to shared economies of scale, such as cheaper prices for components through reduced delivery costs.

External economies Concentration of firms may lead to: An established pool of skilled labour Local schools / colleges offering industry specific training schemes A wide range of support ancillary and commercial services may be offered Firms may co-operate, joining forces to fund R&D Production may be broken up to allow greater specialisation (disintegration); firms may specialise in the production of one component and transport it to a main assembly plant (eg West Mids car industry)

Diseconomies of scale Arise if the scale of a businesses operations expand beyond the minimum efficient scale, average costs rise as output rises. Internal diseconomies of scale Likely to arise due to poor management As firms grow, it becomes more difficult for management to keep control; communication may be an issue Motivation may suffer as individuals lose their identity The break down of one large plant has greater implications than the break down of one of two smaller plants Solutions may include centralising operations, with a small tightly knit team controlling all activities Introducing a charismatic leader to keep tight control of all major decisions Decentralising management with many small subsidiary companies making decisions

Diseconomies of scale Geography may lead to diseconomies if goods have to be transported over long distances Head office may find it more difficult to control costs if the organisation is a long distance away rather than on the doorstop

External Diseconomies The growth of the whole market may raise the average costs of all the firms in the industry. This may occur from overcrowding in industrial areas. Cluster effects may include competition for labour amongst the firms, which raises wages Local traffic congestion may increase

Factors influencing the scale of operation The scale of operation differs widely from industry to industry The source of the economies of scale influence the scale of operation: –Technical economies –Specialisation –Purchasing economies –Marketing economies

Capacity Utilisation The capacity utilisation of a firm measures the amount it is producing compared with the amount it could produce given its existing resources. Capacity Utilisation = Present output x 100 Maximum output Task – List all the ways a firm increase its capacity utilisation?

Capacity Utilisation A firm could increase the amount it is producing Change the marketing mix to stimulate sales Produce products for other firms Close part of its production process

Choosing the optimal mix of resources Businesses will use the cheapest factors, assuming no difference in quality Where there is a difference in quality, the business must balance what it needs against what it can afford If skilled labour is in short supply, the business may have to recruit trainees Some designs, eg recipes, will dictate a strict list of ingredients

Capital or labour intensive? Depends on: The nature of the product – mass produced products use capital intensive; services are labour intensive The relative price of the two factors – China and India offer cheap labour and so use labour intensive production The size of the firm – smaller companies will use less capital

Activity Through research can you identify benefits and drawbacks of capital and labour intensive strategies

The law of diminishing returns As more units of labour are added to a fixed amount of capital, the output of the extra workers will rise at first and then fall Output rises at first as workers specialise, which improves productivity BUT they reach a point where workers are not able to specialise any more and the productivity of the extra worker (marginal output) begins to fall

WorkersTotal OutputAverage OutputMarginal Gain