Changes

Let’s make sure we understand this by looking at another example.  Suppose that hiring one more sales agent at $80 per day in our clothing store enables us to sell 8 more dresses.  What is our marginal cost for dresses at that point?  It is simply the additional cost of $80 (the wage) divided by that employee’s marginal productivity of 8 new sales, yielding a marginal cost of $10 per dress.

Let’s make sure we understand this by looking at another example.  Suppose that hiring one more sales agent at $80 per day in our clothing store enables us to sell 8 more dresses.  What is our marginal cost for dresses at that point?  It is simply the additional cost of $80 (the wage) divided by that employee’s marginal productivity of 8 new sales, yielding a marginal cost of $10 per dress.

===The Long Run===

===The Long Run: Economies of Scale===

Jesus’ teachings were not always what the public wanted to hear.  At one point it seemed like nearly everyone wanted to abandon Him.  Jesus then turned to his apostles and said, “Will ye also go away?”  Simon Peter responded, “Lord, to whom shall we go? thou hast the words of eternal life.”  John 6:68 (KJV).  Peter was committed for the long run.  Over thirty years after Jesus’ crucifixion, Peter remained true to what he said and allowed himself to be crucified (upside down).  Jesus picked apostles for the long run.

The "long run" is the period of a year or longer, depending on the issue.  In the Bible, Jesus looked for disciples who would stick with him for "long run." After many followers left because the teaching was so harsh, Jesus turned to his apostles and said, “Will ye also go away?”  Simon Peter responded, “Lord, to whom shall we go? thou hast the words of eternal life.”  John 6:68 (KJV).  Peter was committed for the long run.  Over thirty years after Jesus’ crucifixion, Peter remained true to what he said and allowed himself to be crucified (upside down).  Jesus picked the Apostles for the long run.

There is a "long run" in most businesses also.  When you are doing business with a supplier you want to be confident it will still be there a year or five years later.  You want to set up your firm so that it is efficient for the long run.  Quick fixes are typically short-lived and inefficient, and long run planning is crucial to long run success.  People who become doctors or lawyers go through more education, when they do not make money, in order to try to succeed in the long run afterward.

Efficiency is maximized by focusing on the long run.  As President of your widget company, you want to maximize the efficiency of your company.  You want the lowest total cost per unit.  You do not want idle workers or equipment.  You do not want wasted inventory.

 

Efficiency is maximized by focusing on the long run.  As President of your widget company, you want to maximize the efficiency of your company.  You want the lowest unit cost.  You do not want idle workers or equipment.  You do not want wasted inventory.  Have you heard the expression “a penny saved is a penny earned?”  It illustrates the real cost of waste.  Actually, due to taxes, a penny saved is worth even more than a penny earned.

The changes you make to your company in the long run will be designed to maximize efficiency.  You want to reduce overtime, and you want loyal workers at a relatively low wages.  You want manufacturing facilities that are utilizing close to 100% of their capacity for production.  If demand is increasing, then that means building new facilities.  If demand is decreasing, then that means selling facilities that you already have.

The changes you make to your company in the long run will be designed to maximize efficiency.  You want to reduce overtime, and you want loyal workers at a relatively low wages.  You want manufacturing facilities that are utilizing close to 100% of their capacity for production.  If demand is increasing, then that means building new facilities.  If demand is decreasing, then that means selling facilities that you already have.

There is a concept for the long run known as “scale”.  It means the total amount of inputs (workers, facilities, equipment, etc.) that a company has.  The “large scale” means large facilities and number of workers.  The “small scale” means small facilities and number of workers.

There is a concept for the long run known as “scale”.  '''''"Scale" refers to the total amount of inputs (workers, facilities, equipment, etc.) that a company has.''''' The “large scale” means large facilities and number of workers.  The “small scale” means small facilities and number of workers.

We expect the output of a company to increase in proportion to the increase in scale.  As President, you may think that doubling everything (facilities, workers, etc.) will double your output.  Often that is true.  When true, this is called “constant returns to scale.”  When scale increases by a factor of ‘x’, then output also increases by the same factor of ‘x’.

We expect the output of a firm to increase in proportion to an increase in scale.  As President, you may think that doubling everything (facilities, workers, etc.) will double your output.  Often that is true.  '''''When output increases on a one-to-one basis with input, this is called “constant returns to scale.”''''' When scale increases by a factor of ‘x’, then output also increases by the same factor of ‘x’.

An assembly line is perhaps the best example of this.  Suppose one assembly line produces 1000 widgets a month.  How much would two assembly lines, with double the workers, produce?  Our first impression would be twice the output, or 2000 widgets a month.

An assembly line is perhaps the best example of this.  Suppose one assembly line produces 1000 widgets a month.  How much would two assembly lines, with double the workers, produce?  Our first impression would be twice the output, or 2000 widgets a month.

But equally important are situations where there are “increasing returns to scale” (output goes up by a greater percentage than the increase in scale) and “decreasing returns to scale” (output goes up by a smaller percentage than the increase in scale).  The popular term “economies of scale” refers to “increasing returns to scale,” which are what one often sees in a well-managed company.

But equally important are situations where there are “increasing returns to scale” (output goes up by a greater percentage than the increase in scale) and “decreasing returns to scale” (output goes up by a smaller percentage than the increase in scale).  '''''The popular term “economies of scale” refers to “increasing returns to scale,” which are what one often sees in a well-managed company.'''''

 

The example of the assembly line may yield slightly increasing returns to scale.  When we double the assembly line, we may not have to double the number of administrative workers like managers, clerks, phone operators, etc.  We won’t need two Presidents, for example.  So we can double our output without doubling our workforce.  Perhaps we can even squeeze the second assembly line into our existing manufacturing plant.  We would still need twice the materials for the goods produced, but not twice the labor and facilities.  In this case we have increasing returns to scale: output doubles when inputs increased by less than 100%.

The example of the assembly line may yield slightly increasing returns to scale. When we double the assembly line, we may not have to double the number of administrative workers like managers, clerks, phone operators, etc.  We won’t need two presidents, for example.  So we can double our output without doubling our workforce.  Perhaps we can even squeeze the second assembly line into our existing manufacturing plant.  We would still need twice the materials for the goods produced, but not twice the labor and facilities.  In this case we have increasing returns to scale: output doubles when inputs increased by less than 100%.

When would a firm have decreasing returns to scale? How could it be that we can double our workers and facilities and not produce at least twice the output?  The reason is that inefficiencies creep in.  Workers may spend more time talking with each other than doing productive work.  Managers and other workers may fight each other for power rather than doing what is best for the company.  People may call in sick more often, knowing that others are there to fill in for them.  Waste could spiral out of control as more purchases are made.  Each employee will feel less needed, and may become less motivated.

When would a company have decreasing returns to scale?  How could it be that we can double our workers and facilities and not produce at least twice the output?  The reason is that inefficiencies creep in.  Workers may spend more time talking with each other than doing productive work.  Managers and other workers may fight each other for power rather than doing what is best for the company.  People may call in sick more often, knowing that others are there to fill in for them.  Waste could spiral out of control as more purchases are made.  Each employee will feel less needed, and may become less motivated.

As President of your company, think before you make long-run changes to increase output: do you have increasing, constant, or decreasing returns to scale?   

As President of your company, think before you make long-run changes to increase output: do you have increasing, constant, or decreasing returns to scale?  Do not, however, confuse decreasing returns to scale with diminishing returns.  Diminishing returns are something that occurs in the short run: it is the decline in marginal productivity as you keep increasing a variable input while all other inputs remain constant.  For example, asking one employee to work more and more overtime is going to have diminishing returns.  He is going to become so tired that he will not work as efficiently as when he is rested.  And even if he did not tire, the added benefit of the worker to your company by himself is going to decline without adding other workers or facilities to support him.  The entirely different concept of decreasing returns to scale refers to long term economic changes due to big modifications to your company.  Diminishing returns are always expected; decreasing returns to scale are not.

Do not confuse decreasing returns to scale with diminishing returns.  Diminishing returns are something that occurs in the short run: it is the decline in marginal productivity as you keep increasing a variable input while all other inputs remain constant.  For example, asking one employee to work more and more overtime is going to have diminishing returns.  He is going to become so tired that he will not work as efficiently as when he is rested.  And even if he did not tire, the added benefit of the worker to your company by himself is going to decline without adding other workers or facilities to support him.  The entirely different concept of decreasing returns to scale refers to long term economic changes due to big modifications to your company.  Diminishing returns are always expected; decreasing returns to scale are not.

A typical firm can initially expect average unit costs to decline as it increases inputs (workers, facilities, etc.) from zero.  This is an increasing return to scale.  But at some point, call it input = X, those increasing returns disappear and the company can only obtain constant returns to scale.  It has attained its “minimum efficient scale” at that point.  It can continue to increase its inputs, but its output only increases by the same amount as its input.  Ultimately, the company will find that increasing inputs further does not even increase output much.  It has too many workers or facilities at that point, and it begins experiencing decreasing returns to scale.

A typical firm can initially expect average unit costs to decline as it increases inputs (workers, facilities, etc.) from zero.  This is an increasing return to scale.  But at some point, call it when input = X, those increasing returns disappear and the company can only obtain constant returns to scale.  It has attained its “minimum efficient scale” at that point.  It can continue to increase its inputs, but its output only increases by the same amount as its input.  Ultimately, the company will find that increasing inputs further does not even increase output much.  It has too many workers or facilities at that point, and it begins to have decreasing returns to scale.

==Costs==

==Costs==