Production Function:

Definition:

A given output can be produced with many different combinations of factors of production (land, labor, capita! and organization) or inputs. The output, thus, is a function of inputs. The functional relationship that exists between physical inputs and physical output of a firm is called production function.

Formula:

In abstract term, it is written in the form of formula:

Q = f (x¹, x², ......., xⁿ)

Q is the maximum quantity of output and x¹, x², xⁿ are quantities of various inputs. The functional relationship between inputs and output is governed by the laws of returns.

The laws of returns are categorized into two types.

(i) The law of variable proportion seeking to analyze production in the short period.

(ii) The law of returns to scale seeking to analyze production in the long period.

Optimum Firm:

Definition and Explanation:

Optimum firm is that firm which fully utilizes its scale of operation and produces optimum output with the minimum cost per unit production.

In the short-run, a firm would build the scale of plant and operate it at a point where the average cost is at its minimum. This is regarded as the optimum level of production for the firm concerned, if the demand for the product increases from this least cost output; it cannot change the amount of land, buildings, machinery and other input in short period of time. It has to move along the same scale or type of plant. The average total cost, therefore, begins to rise due to the diseconomies of the scale.

In the long run, all inputs are variable. The firm can build larger plant sizes or revert to smaller plants to deal with the changed demand for the product. If the size of plant increases to cope with the increased demand, the average cost per unit begins to fall due to the economies of scale such as increased specialization of labor, better and greater specialization of management, efficient utilization of productive equipment, etc., etc. So long as the resources are successfully utilized, the average cost of production continues declining.

Eventually a stage comes when the firm is not able to use the least cost combination of inputs. The building of a still larger plant cause the average cost of production to go up. The point at which the per unit cost is the lowest is the optimum level of production for the firm. The firm of the most efficient size.

Diagram/Figure:

The concept of the optimum firm can be explained with the help of the following figure:

In the diagram (10.1) units of output are measured along OX axis and units of cost along OY axis. In this figure, there are four alternative scales of plant. SAC¹, SAC², SAC³ and SCA⁴.

If the anticipated output rate is OK, the firm should choose the smallest plant, SAC¹. This is due to the fact that the cost per unit for OK output is lowest at point A on plant SAC¹. If the anticipated output rate is OL plant SAC² yields lowest cost per unit at point B. This is the optimum plant of the firm and is of the most efficient size. If a larger plant of the SAC³ size is constructed to meet the rising demand for the product, then the economies of the scale mainly of managerial nature arise. The per unit cost of production begins to arise. Thus the scale SAC² represent the optimum plant and BL is the least cost output of this plant.

Localization of Industries:

Meaning and Definition:

 

By 'localization of industries' is meant the tendency on the part of industries to be concentrated in regions which are most suited for their development.

 

Explanation:

 

Some industries are carried on and developed in certain areas because of their natural or acquired advantages. For example in Pakistan, sugar industry is localized in NWFP and Punjab, paper match box industry in NWFP, cotton industry in Punjab and Sindh, simply on the basis of nearness to source of raw material.

 

Factors:

 

The important factors which influence the localization of industries are discussed as below:

 

(i) Nearness to raw material. One of the very important factor which affects the birth of an industry in certain areas is the nearness to sources of raw material . The availability of raw material near the location of the industry helps considerably in reducing the transport cost and so the total cost of production of the commodity. It is due to this reason that most of the industries are established in regions where the raw material is available in abundance.  Concentration of jute industry in Bangladesh and sugar industry in NWFP are mainly due to these factors.

 

(ii) Availability of source of power. Availability of cheap power resources is another important factor which influences the concentration of industries in particular areas. If for instance, electricity is to be carried over to a long distance where the industry is located or the coal which serves as raw material is to be transported at a far-off distance from whereat is extracted, it will not then he economical to set up the industry at such places which are far away from the sources of power.

 

(iii) Physical and climate conditions. Physical and climatic conditions have an important hearing on the growth of industry. If suitable climate and desirable physical conditions exist for a particular industry, that will he established and developed in that region then.

 

(iv) Nearness to market. Industries have a tendency to be localized in those areas where the market is near at hand. The goods produced can be easily brought in the market and there can be much saving in the cost of transportation.

 

(v) Supply of trained labor. Supply of trained labor is another great attraction for the concentration of an industry in a particular area. If for instance, one wishes to set up a cotton factory, it will be advantageous for him to install it in Faisalabad or Okara.

 

(vi) Availability of capital. Industries may spring up in those areas where capital is available at a lower rate.

 

(vii) Momentum of an early start. Sometimes, it so happens, that an industry gets itself established and developed in a particularly locality not due to the reasons discussed above but Just by some chance or other. Later on, that locality acquires reputation in the production of the commodity and more industries are set up-there. For instance sports goods industry is located in Sialkot for no reason other than this that it got an early start there.

 

Advantages of Localization:

 

When an industry gets itself established in a locality, it enjoys the following advantages.

                          

Firstly, a localized product gains reputation and thus it becomes easy for a firm to find good market within and outside the country. On the basis of reputation, it is generally able to charge higher prices than the products of their counterparts situated elsewhere. For instance, the sports and leather goods manufactured in Sialkot have acquired very good commercial reputation and it is easy to sell them at good prices.

 

Secondly, when an industry is located in a particular region, it is easy to get skilled labor of the industry, industrial skill passes on from father to son. The children team ft almost unconsciously.

 

Thirdly, localization leads to promotion and growth of subsidiary.

 

Fourthly, it results in the development of specialized research institutions.

 

Fifthly, it leads to the spread of fast means of communication and transport.

            

Sixthly, localization encourages the development of financial facilities. When banks and other financing cooperation find profitable field for investment in a locality, they at once open their branches there.

 

Finally, localization provides opportunities both for workers and the industrialists to understand each other and to form themselves into an organization in order to safeguard their respective interest.

 

Disadvantages of Localization: 

      

Localization has certain disadvantages too. They are as following:

 

(i) Localization is dangerous when the demand for the localized products declines due to the growth of foreign competition or due to the changes in the tastes of the people. In that case there will be mass unemployment in the particular localized industries.

 

(ii) Localization results in the economic independence of one locality on the other or of one country on the other; if the commodity demanded is one of the basic necessities of life, it can cause much inconvenience to the depending nations. 

 

(iii) People can learn only one type of work in a localized industry. If they wish to go to another place, they may face difficulty in getting employment.

 

(iv) During war, a localized industry can easily be made a target for bombardment and the whole industry can be ruined to ashes. So it is not wise to place all eggs in one basket. The industry should be decentralized. It should be spread out in various parts of the country so that it may not become an easy target for enemy's air attack.

Survival of Small Scale Firms:

Small scale production firms has the actual survival value side by side with large scale production. The facts are that small scale firms have a firm footing along with the large scale firms. The reasons are that small scale firms concerns enjoy certain advantages which are peculiar to their own. They are following:

Reasons for Survival of Small Scale Firms:

(i) Close supervision. When production is being carried on a small scale, the producer can easily supervise each part of the work. The raw material is fully utilized by avoiding the waste. As the workers are closely supervised they work efficiently. The machines are carefully handled. All this results in lowering of cost production.

(ii) Economic independence. In a small firm, the producer is generally the sole proprietor himself. When he clearly knows that the whole profit will go to him and not to anybody else, he works untiringly.

(iii) Economy in management. A large firm has to spend a sizeable portion of the income on maintaining administrative machinery but that is not the case with the small firm. In a small firm, the proprietor himself is the manager. He does not need superfluous account keeping. He just writes the income and expenditure of his business on a small notebook and keeps that with himself.

(iv) Close contact with customers. As the, workers employed in a small firm are few in number, the employer can have a close contact with them. He can listen to their grievances personally and can redress them if he thinks  them justified. Due to better understanding between the and the employees, the chances of industrial disputes are reduced.

(v) Greater adaptability to Changes. Another advantage claimed by a small firm is  that it can easily adjust its supply to the changed conditions in demand. As the small firm has not to consult the various share-holders of the business, so it can easily arrive at quick decisions and these decisions can be promptly executed.

Small Scale Firms VS Large Scale Firms:

In addition to the advantages discussed above, there are some special circumstances where small scale production is most suitable and economical than large scale production:

Advantages of Small Scale Production Firms:

(i) When the demand for a commodity is small and is expected to remain as such for many years to come, then the production will not be carried out on a large scale. Similarly, if the demand is of a fluctuating nature, the goods are produced on small scale and not on large scale.

(ii) Production is also carried on small scale where the scope of division of labor is limited. For example, in tailoring, repairing agricultural concerns, the division of labor cannot be introduced on a large scale. In tailoring, the clothes are prepared according to the individual tastes of the customers. So, is also the case in repairing. In agricultural work cannot be divided into processes and sub-processes. So, it is generally organized on a small scale.

(iii) Small scale production is also able to hold its own in that field where production is carried on according to the individual tastes. For instance, in jewellery, embroidery works and in other autistics wares, the demand is met locally and the work is done strictly according to the wishes of the customers customers.

(iv) The goods are also produced on small scale where it is not possible to standardize them.

Economics of Large Scale Production:

Classifications/Types and Explanation:

The economies of large scale production are classified by Marshall into:

(1) Internal Economies and (2) External Economies.

(1) Internal Economies of Scale:

Definition and Types:

Internal economies of scale are those economies which are internal to the firm. These arise within the firm as a result of increasing the scale of output of the firm. A firm secures these economies from the growth of the firm independently. The main internal economies are grouped under the following heads:

(i) Technical Economies: When production is carried on a large scale, a firm can afford to install up to date and costly machinery and can have its own repairing arrangements. As the cost of machinery will be spread over a very large volume of output, the cost of production per unit will therefore, be low.

A large establishment can utilize its by products. This will further enable the firm to lower the price per unit of the main product. A large firm can also secure the services of experienced entrepreneurs and workers which a small firm cannot afford. In a large establishment there is much scope for specialization of work, so the division of labor can be easily secured.

   

(ii) Managerial Economies: When production is carried on a large scale, the task of manager can be split up into different departments and each department can be placed under the supervision of a specialist of that branch. The difficult task can be taken up by the entrepreneur himself. Due to these functional specialization, the total return can be increased at a lower cost.

(iii) Marketing Economies: Marketing economies refer to those economies which a firm can secure from the purchase or sale of the commodities. A large establishment is in a better position to buy the raw material at a cheaper rate because it can buy that commodities on a large scale. At the time of selling the produced goods, the firm can secure better rates by effectively advertising in the newspapers, journals and radio, etc.

(iv) Financial Economies: Financial economies arise from the fact that a big establishment can raise loans at a lower rate of interest than a small establishment which enjoys little reputation in the capital market.

              

(v) Risk Bearing Economies: A big firm can undertake risk bearing economies by spreading the risk. In certain cases the risk is eliminated altogether. A big establishment produces a variety of goods in order to cater the needs of different tastes of people. If the demand for a certain type of commodities slackens, it is counter balanced by the increase in demand of the other type of commodities produced by the firm.

(vi) Economies of Scale: As a firm grows in size, it is-possible for it to reduce its cost. The reduction in costs, as a result of increasing production is called economies of scale. The economies of scale are obtained by the firm up to the lowest point on the firms long run average cost curve. The main sources of economies of scale are in brief as under.:

            

Diseconomies of Scale:

Definition:

            

The extensive use of machinery, division of labor, increased specialization and larger plant size etc., no doubt entail lower cost per unit of output but the fall in cost per unit is up to a certain limit. As the firm goes beyond the optimum size, the efficiency of the firm begins to decline. The average cost of production begins to rise.

Factors of Diseconomies:

The main factors causing diseconomies of scale and eventually leading to higher per units cost are as follows: 

                                    

(i) Lack of co-ordination. As a firm becomes large scale producer, it faces difficulty in coordinating the various departments of production. The lack of co-ordination in the production, planning, marketing personnel, account, etc., lowers efficiency of the factors of production. The average cost of production begins to rise.

                       

(ii) Loose control. As the size of plant increases, the management loses control over the productive activities. The misuse of delegation of authority, the redtapisim bring diseconomies and lead to higher average cost of production.

(iii) Lack of proper communication. The lack of proper communication between top management and the supervisory staff and little feed back from subordinate staff causes diseconomies of scale and results in the average cost to go up.                              

(iv) Lack of identification. In a large organizational structure, there is no close liaison between the top management and the thousands of workers employed in the firm. The lack of identification of interest with the firm results in the per unit cost to go up.

(2) External Economies of Scale:

Definition and Types:

External economies of scale are those economies which are not specially availed of by .any firm. Rather these accrue to all the firms in an industry as the industry expands. The main external economies are as under:

(i) Economies of localization. When an industry is concentrated in a particular area, all the firms situated in that locality avail of some common economies such as (a) skilled labor, (b) transportation facilities, (c) post and telegraph facilities, (d) banking and insurance facilities etc.

(ii) Economies of vertical disintegration. The vertical disintegration implies the splitting up the production process in such a manner that some Job are assigned to specialized firms. For example, when an industry expands, the repair work of the various parts of the machinery is taken up by the various firms specialists in repairs.

(iii) Economies of information. As the industry expands it can set up research institutes. The research institutes provide market information, technical information etc for the benefit of alt the firms in the industry.

(iv) Economies of by products. All the firms can  lower the costs of production by making use of waste materials.

  

External Diseconomies:

Definition:

A firm or an industry cannot avail of economies for an indefinite period of time. With the expansion and growth of an industry, certain disadvantage also begin to arise. The diseconomies of large scale production are:

(i) Diseconomies of pollution, (ii) Excessive pressure on transport facilities, (iii) Rise in the prices of the factors of production, (iv) Scarcity of funds, (v) Marketing problems of the products, (iv) Increase in risks.

What is Scale of Production?

Definition:

"Scale of production is set by the size of plant, the number of plants installed and the technique of production adopted by the producer".

Classifications/Types:

The scale of production is classified as under:

      

(i) Small Scale Production.

(ii) Large Scale Production.

(iii) Optimum Scale of Production.

(i) Small Scale Production: If a firm produces goods with small sized plants, the scale of production is said to be small scale production. Small scale of production is associated with low capital output and capital labor ratios. In small scale of production, the economies of scale do not occur to the firm.

(ii) Large Scale of Production: If a firm uses more capital and larger quantities of other factors, it is said to be operating on large scale production. Large scale production enjoys both internal and external economies of scale.

(iii) Optimum Scale of Production. The optimum scale of production refers to that size of production which is accompanied by maximum net economics of scale, it is a scale at which the cost of production per unit is the lowest.

Capital Market

Definition:

The means by which large amounts of money (capital) are raised by companies, governments and other organizations for long term use and the subsequent trade of the instruments issued in recognition of such capital.

Types:

There are two types of financing/capital markets:

(1) Money Market.

(2) Capital Market. 

(1) Money Market:

Money market is the market for very short term loans. It mainly centers round its activities on the discount houses, the commercial banks. The money market, deals in various credit instruments such as, the bill of exchange, short dated bonds, certificate of deposits, the treasury bills, etc.

                

(2) Capital Market:

Capital market refers to a market where the financial institutions mobilize the savings of the people and lend them for long term, period for raising new capital in country. Capital Market, in other words, refers to the long term borrowing and lending of capital funds.

Capital Market Instruments:

The principal capital market instruments used for long term funds are:

(i) Mortgages.

(ii) Corporation bonds.

(iii) State and local government bonds.

(iv) Federally sponsored credit agency securities.

(v) Finance company bonds.

(vi) Commercial banks bonds and commercial paper.

(viii) Corporate stock.

Institutional sources of Capital Market:

There are a number of financial institutions which are directly involved with real investment in the economy. These institutions mobilize the saving from the people and channel funds for financing the development expenditure of the industry and government of a country.

The financial institutions take maximum care in investing funds in those projects where there is high degree of security and the income is certain. The main institutional sources of capital market are as follows:

(i) Insurance Companies. Insurance companies are financial intermediaries. They call money by providing protection from certain risks to individuals and firms. The insurance companies invest the funds in long term investments primarily mortgage loans and corporate bonds.

(ii) Pension Funds. The pension funds are provided by both employees and employers. These funds are now increasing utilized in the provision of long term loans for the industry and government.

(iii) Building Societies. The building societies are now activity engaged in providing funds for the construction, purchase of buildings for the industry and houses for the people.

(iv) Investment Trusts. The investment trust mobilize saving and meet the growing, need of corporate sector, The income of the investment trust depends upon the dividend it receives from shares invested in various companies. 

(v) Unit Trust. The Unit Trust collects the small savings of the people by selling units of the trust. The holders of units can resell the units at the prevailing market value to the trust itself. 

   

(vi) Saving Banks. The saving banks collect the savings of the people. The accumulated saving is invested in mortgage loans, corporate bonds.

(vii) Specialized Finance Corporation. The specialized finance corporations are being established to help and provide finance to the private industrial sector in the form of medium and long term loans or foreign currencies.

(viii) Commercial banks. The commercial banks are also now activity engaged in the provision of medium and long terms loans to the industrialists, agriculturists, specialist finance institutions, etc., etc.

(ix) Stock Exchange. The stock exchange is a market in existing securities (shares, debentures and securities issued by the public authorities). The stock exchange provides a place for those persons who wish to sell the shares and also wish to buy them. Stock exchange, thus helps in raising equity capital for the industry