Firms and Production

Production and productivity

These sound similar and mean different things, which is exactly why the exam tests them.

• Production is the total output produced.
• Productivity is output per unit of input, usually output per worker or per hour.

A factory that hires 10 more workers and makes more goods has raised production. If output per worker has not changed, productivity is the same.

Raising productivity is what matters most, because it lowers the cost of each unit and makes the firm more competitive. Ways to raise it: training, better technology, better management, specialisation and division of labour, and improved worker motivation.

Division of labour means splitting production into separate tasks, each done by a different worker. It raises productivity through practice and specialisation, but can make work repetitive and boring, which may lower motivation and quality.

Demand for factors of production

Demand for factors is derived demand, firms want land, labour and capital for what they can produce, not for their own sake.

Demand for a factor depends on:

• Demand for the product it makes.
• The productivity of the factor, more productive factors are worth more.
• The price of the factor itself.
• The price of substitute factors: if machines get cheaper, firms use fewer workers.

Labour-intensive and capital-intensive production

• Labour-intensive production uses a high proportion of labour relative to capital, hairdressing, farming in low-income countries, hand-made goods.
• Capital-intensive production uses a high proportion of machinery, car manufacturing, oil refining, bottling plants.

What firms consider when choosing:

This is why the same product can be made differently in different countries: where wages are low, firms use more labour; where wages are high, they replace workers with machines.

Economies of scale

Economies of scale are the cost advantages of producing on a larger scale, average cost falls as output rises.

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Diseconomies of scale

Beyond a certain size, average cost starts to rise again:

• Communication problems: messages take longer and get distorted in a large organisation.
• Coordination problems: managing many departments and sites is harder.
• Poor motivation: workers feel like a small part of a big machine, so effort falls.

So the average cost curve is U-shaped: falling while economies dominate, then rising once diseconomies take over.

Worked example

A bakery expanding from one shop to twenty branches.

1. Buying flour for twenty shops earns a bulk discount (purchasing economies)
2. it can afford large industrial ovens that produce more per hour (technical)
3. a bank lends more cheaply to a bigger business (financial)
4. it can hire a full-time accountant instead of paying an outside firm (managerial)
5. one advertising campaign now serves twenty shops (marketing)
6. average cost per loaf falls.

But push further. At two hundred branches, head office may struggle to keep track of what each shop needs, staff may feel disconnected from the business, and decisions slow down. Waste rises, and average cost per loaf starts to climb, diseconomies of scale.

The judgement: growth lowers costs up to a point, and the skill is knowing where that point is.

Common exam mistakes

• Confusing production (total output) with productivity (output per input).
• Saying economies of scale mean total costs fall. Total costs usually rise with output; average cost falls.
• Giving only one type of economy of scale when several are expected.
• Forgetting diseconomies of scale exist.
• Saying capital-intensive is always better. It depends on relative costs and the product.
• Treating division of labour as having no drawbacks.

Exam technique

Use the phrase average cost when discussing economies of scale; that is what actually falls, and examiners check for it.

When asked for types of economies of scale, name the type and explain the mechanism: "purchasing economies, buying in bulk earns a discount, so each unit costs less."

For labour- versus capital-intensive questions. Always compare the relative cost of the two, and mention the type of product.

Building an answer

4 marks, "Distinguish between labour-intensive and capital-intensive production."

Labour-intensive production uses a high proportion of labour relative to capital, hand-finished clothing, hairdressing, care work.
Capital-intensive production uses a high proportion of machinery relative to labour, car assembly, oil refining, bottling plants.
Firms choose between them mainly on relative cost: where wages are low relative to the cost of capital, labour-intensive methods are cheaper.

6 marks, "Analyse why a firm might switch from labour-intensive to capital-intensive production."

Rising wages raise the relative cost of labour, so substituting machinery lowers total cost per unit.
Machinery also raises productivity and consistency: it works continuously, does not tire, and produces more uniform output, which raises quality and reduces waste.
Larger output volumes make the fixed cost of the machinery worth bearing, since it is spread over more units.
Against this, the initial investment is large and the firm loses flexibility, machinery cannot easily be redeployed if demand changes, and redundancies may damage morale and reputation.

Productivity, and why it is not the same as production

Students lose marks here more often than anywhere else in Unit 3.

A firm that doubles its workforce and doubles output has raised production and left productivity unchanged. Only a rise in output per worker is a productivity gain, and productivity, not production, is what determines living standards over time.

A real case to quote

Amazon warehouses. Robotic systems move shelves to pickers rather than pickers walking to shelves, cutting the distance a worker covers by miles per shift. Output per worker rose sharply, a genuine productivity gain, while total employment also rose, because the lower cost per item expanded the business. It is a useful counter to the assumption that automation always means fewer jobs.

Quick revision

• Production = total output. Productivity = output per unit of input.
• Division of labour raises productivity but can lower motivation.
• Demand for factors is derived from demand for the product.
• Labour-intensive vs capital-intensive depends mainly on relative costs and the product.
• Economies of scale: purchasing, technical, financial, managerial, marketing, risk-bearing, average cost falls.
• Diseconomies: communication, coordination, motivation, average cost rises.
• The average cost curve is U-shaped.

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