Production with 2 OPs —Chapter 6

8/2/2019 Production with 2 OPs Chapter 6

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PRODUCTION WITH TWO OUTPUTS

ECONOMIES OF SCOPE6.5

Product Transformation Curves

Product Transformation Curve

The product transformationcurve describes thedifferent combinations of

two outputs that can beproduced with a fixedamount of productioninputs.

The product transformationcurves O1 and O2 areconcave because there areeconomies of scope inproduction.

product transformation curve Curve showing thevarious combinations of two different outputs (products)

that can be produced with a given set of inputs.


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Economies and Diseconomies of Scope

economies of scope Situation inwhich joint output of a single firm isgreater than output that could beachieved by two different firms when

each produces a single product.

diseconomies of scope Situationin which joint output of a single firmis less than what could be achievedby separate branches of the same

firm ( when each produces a singleproduct ).


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The Degree of Economies of Scope

Defined as: What percentage of the cost of production is savedwhen two (or more) products are produced jointly rather thanindividually.


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THE LEARNING CURVE6.6

As management and labor gain experience with production, the firms

marginal and average costs of producing a given level of output fall.

Reasons:

1. Workers often take longer to accomplish a given task the first few timesthey do it. As they become more adept, their speed increases.

2. Managers learn to schedule the production process more effectively,from the flow of materials to the organization of the manufacturing itself.

3. Engineers who are initially cautious in their product designs may gain

enough experience to be able to allow for tolerances in design that savecosts without increasing defects. Better and more specialized tools andplant organization may also lower cost.


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The Learning Curve

A firms production cost

may fall over time asmanagers and workersbecome more experiencedand more effective at using

the available plant andequipment.

The learning curve showsthe extent to which hours oflabor needed per unit ofoutput fall as the cumulativeoutput increases.

Learning curve


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Resplendence

What does Economies Of Scale mean?

The increase in efficiency of production as the number of goods beingproduced increases. Typically, a company that achieves economies of scalelowers the average cost per unit through increased production since fixed

costs are shared over an increased number of goods.

Layman explanation- Economies Of Scale

Economies of scale gives big companies access to a larger market byallowing them to operate with greater geographical reach. For the more

traditional (small to medium) companies, however, size does have its limits.

After a point, an increase in size (output) actually causes an increase inproduction costs. This is called "diseconomies of scale".


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The learning curve is based on the relationship

Where, N Cumulative output.

L labor input per unit of output.

A, B & Beta are constants.

Learning versus Economies of Scale

Economies of Scale versus Learning

A firms average cost of production

can decline over time because ofgrowth of sales when increasingreturns are present (a move from A

to Bon curve AC1),or it can decline because there is alearning curve (a move from A oncurve AC1 to Con curve AC2).


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Learning Curve for AirbusIndustrie

The learning curverelates the labor

requirement peraircraft to thecumulative number ofaircraft produced.

As the productionprocess becomesbetter organized and

workers gain familiaritywith their jobs, laborrequirements falldramatically.


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ESTIMATING AND PREDICTING COST6.7

cost function Function relating cost of

production to level of output and other variablesthat the firm can control.

Variable Cost Curve for theAutomobile Industry

An empirical estimate of thevariable cost curve can beobtained by using data forindividual firms in an industry.

The variable cost curve forautomobile production isobtained by determiningstatistically the curve that best

fits the points that relate theoutput of each firm to the firms

variable cost of production.


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Predicting cost accurately:

Here is Linear Cost function that we might choose:

Quadratic Cost function:

If the marginal cost curve is none of the above, we might use a cubiccost function:

* VC

Variable Cost of production


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Cubic Cost Function

A cubic cost functionimplies that the averageand the marginal costcurves are U-shaped.


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ESTIMATING AND PREDICTING COST

Cost Functions and the Measurement ofScale Economies

Where, EC Cost output elasticity.

EC

> 1 ( for diseconomies of scale )

EC < 1 ( for economies of scale )

6.7

The scale economies index(SCI) provides an index of whether or not theare s selected economies are scale economies.

SCI is defined as follows:

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Production with 2 OPs —Chapter 6