PRODUCTION ECONOMIES

Production economies may arise from the factor labor, fixed capital or from the inventory requirements of the firm.
1. Labor Economies: Labor economies are achieved as the scale of output increases because of specialization, time saving, automation of production process and cumulative volume. Large-scale production allows division of labor and specialization of the labor force with an improvement of the skills and hence of the productivity of the various types of labor. Division of labor not only increases the skills of the labor force but also results in saving of the time. It promotes the invention of tools and machines that facilitate and supplement the workers. Such mechanization of the production methods in larger plants increases the productivity of labor and leads to decreasing costs as the scale of output increases. With increasing scale there is ‘cumulative effect’ on the skills of technical personnel in particular Production engineers, foremen and other production employees tend to acquire considerable experience from large-scale operations. This ‘cumulative –volume’ experience leads to higher productivity and hence to reduced costs at larger levels of output.

2. Technical economies:Technical economies are associated with the ‘fixed capital’ that includes all types of machinery and other equipment. The important technical economies emerge from (i) specialization and indivisibilities of capital, (ii) set-up cost, initial fixed costs, (iii) technical volume/input relations and (iv) reserve capacity requirement. The main technical economies result from the specialization of the capital equipment and from the indivisibilities Modern technology usually involves a higher degree of mechanization for larger scales of output. Mechanization often implies more specialized capital equipment as well as more investment, a fact that makes the large-scale methods of production have high overhead costs. Of course these methods have lower variable costs, but at low levels of output the high average fixed costs more than offset the lower labor (and other operating) costs. Once the appropriate scale is reached the highly mechanism and specialized techniques become profitable. Set-up costs are the costs involved in the preparation (arrangement) of multi-purpose machinery for performing a particular job or product. For example in the firms producing electrical household equipments the use of general-purposes machines is quite common. The larger the scale of output the more a multipurpose machine is left to one set-up and hence resetting becomes less frequent. This is a source of technical economies of large-scale production.  ‘Initial costs’ are usually involved in starting a business or introducing a new product. Research and development expenditures, costs of market exploration, design costs for the product are examples of such costs. Clearly the large the scale of output, the lower the unit costs of ‘initial expenses’ Technical economies of scale also arise from some technical-geometric relationships between particular equipment and the inputs required to produce and install it are important in the so-called 'process industries', such as petroleum refining, generation, gas transmission, chemical industry, cement industry, glass manufacturing and iron reduction.  The methods of production used in the 'process-industries includes special equipment, such as storage tanks, reaction chambers, con pipes, etc. The material and labor costs of constructing such plants are proportional (to the surface area that they occupy. But the volume capacity (which determine level of output) of a plant increases more than proportionately .as the area in Hence the technical cost of installing such industrial plants falls as the output (, capacity increases, at least up to 1he point where the equipment becomes so large as to require stronger materials and special constructions in order to make the large safe. Another source of technical economies is the so-called 'reserve-capacity' economies. Firms always want some reserve capacity in order to avoid disruption of their production flow when breakdown of machinery occurs. A small firm using a single large machine will have to keep two such machines if it wants to avoid disruptions from a breakdown.

3. Inventory economies: The role of inventories is to face the random changes in the input and the output sides of the operations of the firm. Stocks of raw materials do increase with scale but not proportionately. Random fluctuations in the supply of such inputs are smoothed out with stocks whose size needs change by less than the size of the firm. The 'reserve-capacity' economies are also a type of stochastic economies. The breakdowns in machinery do not increase pari passu with size. If anything the 'cumulative volume' experience of production personnel will tend to reduce the frequency of such breakdowns in larger plants, and require proportionately smaller amount of reserve machinery and stocks of spare parts. Similarly on the demand side, random changes in the demand of customers will tend to be smoothed out as the plant size increases.