Question

1. The President of Company ABC in its annual meeting to Stockholders, he reported that

“the more they produced, the lower the average cost of production.”

1. What economic concept can be attributed to this economic phenomenon?
2. Briefly discuss 5 factors that can cause this trend.
3. Briefly discuss 5 factors that can reverse this trend.

Answer 1

The President of Company ABC in its annual meeting to Stockholders, he reported that “the more they produced, the lower the average cost of production.”

a. What economic concept can be attributed to this economic phenomenon?

1. Law of increasing returns to a factor, where K (fixed factor) remains constant but production quantity is increased by way of increasing the L (variable factor such as labour).
2. Law of returns to scale, where both K and L factors become variable factors and production quantity is increased by way of increase the both simultaneously in the ratio not changing.
3. Law of variable proportions (LVP) in the short run - Especially the production performance before reaching the Ideal Factor Ratio.
4. Reaching the IDEAL FACTOR RATIO, which means using the best combination of fixed K with variable units of L to gain the maximum MP (marginal product) per unit of labour. The marginal cost is minimum here.
5. Law of returns to scale because of the following scenarios
   1. Benefits of concentration
   2. Economies of scale
6. Law of increasing returns to a factor, due to following reasons:
   1. Better utilization of fixed factor
   2. Increased efficiency of variable factor
   3. Indivisibility of fixed factor
   4. Better coordination amonst the variable factors (Labour)
   5. Proper division of labour based upon individual specialization of the labour

b. Briefly discuss 5 factors that can cause this trend.

1. Efficient utilization of fixed costs
2. Better coordination among factors
3. Economies of scale:
   1. Internal economies (with in a firm)
   2. External economies (outside a firm, such as in an industry)
4. Postponement of the law of increasing return to a factor (in short run)

c. Briefly discuss 5 factors that can reverse this trend.

1. Diminishing returns to a factor (in short run)
2. Fixity of a factor: You cannot put 100 workers on a single machine which can accomodate only 50 maximum at a time.
3. Imperfect factor substitutability: You cannot substitute a new costly machine with more labours infintely on the existing old machine you have.
4. Poor coordination betweent the factors: Having too many resource may result in to a 'crowd' of them and may not remain as productive.
5. Diseconomies outweighing economies of scale
6. Rigidities due to large management
7. Procrastination due to expansive organizational structure
8. Diseconomies setting in after a limit of economies of scale