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Marginal Product and Marginal Cost, the Factors Which Give Rise to Economies of Scale

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Introduction

Marginal cost (MC) is defined to as cost incurred in generating an incremental unit of output. It is also known as incremental cost. Marginal cost of production includes all of the costs that vary with that level of production.

For example, if a company needs to build an entirely new factory in order to produce more goods, the cost of building the factory is a marginal cost.

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Marginal costs (MC) are variable costs consisting of labor and material costs, plus an estimated portion of fixed costs such as overheads and selling expenses.

Marginal cost (MC) is the cost of one additional unit of output. The concept is used to determine the optimum production quantity for a company, where it costs the least amount to produce additional units.

Marginal costs is an important measurement because it accounts for increasing or decreasing costs of production which allows a company to evaluate how much they actually pay or to produce one more unit.

The formula to obtain the marginal cost is change in costs in quantity. The quantity of output produced and marginal cost is taken on X- axis and Y- axis respectively. The MC curve first declines with increase in output, so the MC curve falls.

At a certain level of output, MC becomes minimum. So the MC curve reaches its minimum point. If the production is increased beyond the level of output, the Marginal cost starts rising. Therefore, the curve slopes upward. Marginal product (MP) is the incremental output produced by employing an additional unit of labor. The marginal product of a business is the additional output created as a result of additional input placed into the company.

For example, marginal product may be the increased number of products produced with the addition of one extra worker on a production line.

In marginal product all the factors remain constant. To calculate marginal product of labor you simply divide the change in total product by the change in labor.

Marginal product is the change in total output as one additional unit of input is added to production.

MP and quantity of labor is represented on X- axis and Y-axis respectively. The shape of MP curve is U- shaped due to law of diminishing marginal returns to factor. The law states that in initial stages, the marginal product increases, it become maximum and starts falling when more units of labor are employed. The output increases when more and more labor is hired.

In the short-run, it is assumed that all the factors except labor remain constant. So, initial stages of production when additional labor units are hired, the marginal product of labor increases.

At some specific level of output, MP reaches its maximum point. Adding extra unit of labor will cause marginal product to diminish. If the producer keeps employing additional labor, the marginal product will become negative.

The Reasons Why Economies of Scale Give Rise to Lower Per Unit Costs

Firstly, specialization of labor and more integrated technology boost production volumes. Secondly, lower per unit costs can come from bulk orders from suppliers, larger advertising buys or lower cost of capital. Thirdly, spreading internal function costs across more units produced and sold helps to reduce costs.

Internal functions include accounting information technology and marketing. If a company wants to create a diseconomy of scale when it becomes too large and chases an economy of scale.

Definition of Economies of scale

Economies of scale are cost advantages reaped by companies when production becomes efficient. Economies of scale or economies of mass production explain the down sloping part of the long-run ATC curve. As plant size increases, a number of factors will for a time lead to lower average costs of production.

Labor Specialization

Increased specialization in the use of labor becomes more achievable as a plant increases in size. Hiring more workers means jobs can be divided and subdivided.

Workers can work full time on the tasks for which they have special skills. In a small plant, skill machinists may spend half their time performing unskilled tasks, leading to higher production costs.

Further, by working at fewer tasks, workers become more proficient at those tasks. Concentrating on one task the same worker may become highly efficient.

At last greater labor specialization eliminates the loss of time that accompanies each shift of a worker from one task to another.

Managerial Specialization

Large scale production also means better use of and greater specialization in management. A supervisor who can handle 20 workers is underused in a small plant. The production staff could be doubled with no increase in supervisory costs.

In a small plant a sales specialist may have to divide his or her time between several executive functions, for example marketing and finance. A larger scale of operations means that the marketing expert can supervise marketing full time, while specialists perform other managerial functions. Greater efficiency and lower unit costs are the net result.

Efficient Capital

Small firms often cannot afford the most efficient equipment. In many lines of production such machinery is available only in very large and extremely expensive units. In addition effective use of the equipment demands a high volume of production and that again requires large-scale producers.

In the automotive industry the most efficient fabrication method employs robotics and elaborates assembly line equipment. Very large-scale producers can afford to purchase and use this equipment efficiently. The small- scale producer is faced with a dilemma. To fabricate automobiles using other equipment is inefficient and therefore most costly per unit.

Other Factors

Many products entail design and development costs, as well as other ‘’start-up” costs, which must be incurred regardless of projected sales. Which must be incurred regardless of projected sales? These costs decline per unit as output is increased. The firm’s production and marketing expertise usually rises as it produces sells more output. This is called learning by doing a source of economies of scale. All these factors contribute to lower average total costs for the firm.

When economies of scale are possible, an increase in all resources, e.g. 10 percent will cause a more- than- proportionate increase in output, for example 20 percent.

Explaining of Economies of Scale: Internal versus External Economies of Scale

There are two different types of Economies of Scale. Internal economies are borne from within the company. External are based on external factors. Internal economies of scale happen when a company cuts costs internally. So, they are unique to that particular firm. Larger companies may be able to achieve internal economies of scale causes lowering their costs and raising their production levels. They can access more capital. On the other hand, external economies of scale are achieved because of external factors which can affect an entire industry. For that no company controls costs on its own.

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