Question

1. How can capital indivisibility create an economy of scale?

2. Adam Smith claimed that he had discovered the most important factor affecting productivity. What was he referring to?

3. What is craft production?

4. What type policy did Adam Smith advocate in order to realize this economy of scale?

5. Large firms can often buy inputs in large quantities. This often creates an ________.

Diseconomies of Scale – Sources and Possible Remedies  

6. What are the most important diseconomies of scale at the plant level? _________. What is the solution to this problem? ___________

7. What is the most important diseconomy of scale at the firm level? _________ How have firms addressed this issue? _______

• US Steel was created to monopolize the steel industry. It had a 64% market share. What happened next? Did US Steel find a solution to its diseconomy of scale?
• Downsizing?
• “Taylorism?” How have workers usually reacted to Taylorism? Why did the Soviet leader V.I. Lenin think that Soviet workers would embrace “Taylorism?” Did Soviet workers like Taylorism?
• piece-rate pay?
• Piece-rate pay can be an effective solution to shirking, however, it does require that the firm use or employ a _____ to make sure that workers do not cut corners.
• Requiring managers to buy the company’s stock?
• Creating residual claimants?
• hostile take overs? Compared to the U.S., hostile take overs have been rare in Europe and Japan. What have been the consequences for Europe from not allowing hostile take overs? _____________. What have been the consequences for Japan from not allowing hostile take overs? ______________
• efficiency wage?

Answer 1

Capital indivisibility and economies of scale - When firms operate on a large scale, they can employ costly capital equipment in order for the whole unit to become more productive. As the scale of production is large, and capital equipment is indivisible when a company operates at a larger scale, it can fully utilize such equipment and can get better returns on the investment in the equipment. It can employ its labor in more than one shift, and even if laborers work in two shifts the production gets doubled. If a company works on a smaller scale and buys such costly equipment, it cannot recover the cost of the equipment and the production cost will rise instead of decreasing. So when a company works at a higher level of production with multi-production units, it can fully utilize the capital. Thus indivisibility of capital brings economies of scale to large firms operating at a higher scale with multiple production units.

Adam Smith claimed that he had discovered the most important factor affecting productivity and such factor is labor - According to Adam Smith, labor is the most important factor of production. And the efficiency of labor affects productivity at most. When laborers become more efficient the production will rise. Smith explains that laborers are the wage earners who earn by working harder every day, and ultimately the wage they earn is used for purchasing goods and services manufactured by different firms. So if laborers are not there then the production will not be possible and neither the firms will be able to sell their goods since there will be no wage earners and the demand for commodities will decline. Along with labor, capital and technology are other two important factors. The land is the least important factor in production according to him.

Craft Production - Craft production is the process of manufacturing goods using only laborers and raw materials without the use of any equipment or machinery. It is a labor-intensive process of manufacture. Generally, products that are hand-made are referred to as craft products. This kind of production technique is used to manufacture unique products which are generally exclusive from each other. The whole method is based on creativity to an extent. The uniqueness of each laborer makes craftwork more effective. Such items are priced higher compared to the products made in batches and are homogenous since craft production is generally used for producing differentiated products.

To realize economies of scale Adam Smith advocated the policies of the division of labor and specialization and technology-

Division of labor is an important aspect of Adam Smith's theory which holds the utmost importance even in today's world. Basically nowadays all the firms are focusing on the division of labor according to their skills, competence, and knowledge. With better training, labor can produce more quantity with greater efficiency. If the laborers are divided into specific tasks, each labor will do a particular job, such labor will master the process for such a job gradually, and the production will increase. As they are doing repetitive jobs, the chances of error reduce as the labor is only doing one job, he knows the process better and can be highly efficient. This way the wastage gets reduced resulting in a reduction in the cost of production and internal economies of scale. Internal economies of scale refer to the advantages a firm gets from its own production system and plans, since better production technique reduces the cost, it can avail such opportunity which is termed as internal economies of scale since the firm itself is responsible for the benefits it is getting due to large scale production, advanced technology, and division of labor.

Specialization and technology is another aspect of his theory. When a firm specializes in producing a particular commodity it can gain comparative advantage over other firms producing the same product. Since it will have vast knowledge and experience in producing a particular product, the research and development can help in gaining such comparative advantage as it can invent the best production methodology at the lowest cost. When it produces a particular specialized product in bulk, with advanced technology, it can utilize advanced equipment and division of labor in order to produce better products at a lower cost. Since the scale of production is more it can also purchase raw materials and inputs at a cheaper price which is another economy of scale that can help in higher productivity at the lowest cost and thus it will also help the consumers since the price for a product for which the cost of production is less can be priced at a lower cost even after keeping the same profit margin. Since the production cost reduces, the product price also gets reduced.

Note: Since there are many questions, answers to the first four questions have been provided.