Production and efficiency

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Production and Productivity


  • The process by which inputs are converted into outputs
  • Inputs -  four factors of production
  • Entrepreneur  - Decides what, where, how much to produce and also how much of the other factor of services to employ
  • Economists presume that the entrepreneur (and the firm) has a profit-maximising objective
  • Profit  - difference between total sales revenue earned from the sale of goods or services and the total costs of production 
  • If the capital and land employed by a firm are fixed, at least in the short run, the only way a firm can increase production is by employing more factors of production such as labour.
  • To start with the more labour employed, the labour productivity may rise - benefit from specialisation and the division of labour
  • This is necessary for trade and exchange 
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Economies and Diseconomies of scale

  • Labour productivity also rises when a firm benefits from economies of scale (but falls if it eventually suffers from diseconomies of scale)
  • Economies of scale occur when a firm experiences falling average costs as it increases its size and scale and produces more output
  • If beyond a certain size of a firm average costs begin to rise, diseconomies of scale set in

Types of economies of scale 

  • Techinal - If a firm increases the amount of storage capacity it has, average costs fall as the size or scale of storage capacity increases 
    - However diseconomies of scale could set in as storage capacity increases - stored materials may become mislaid or lost more easily and the firm owning the warehouse would be tempted to store unnecessary stocks of raw materials of goods awaiting sale 
  • Managerial - these occur because large firms can employ specialist and more highly skilled managers
    - However too many managers and a breakdownn of communication between them result in managers diceconomies of scale  
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Productive efficiency

  • The level of output produced at the lowest average cost of production is known as the productively efficient level of output
  • when economies of scale are possible, expanding the size and scale of the firm can get rid of productive inefficiency and move output towards the productively efficient level
  • On the economies of scale diagram it is at the lowest point of the 'U' on the firms average cost curve 
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