UNIT – 3

Cost and Production Analysis

❖ Concept and types of Costs

❖ Cost-Output Relationships & Cost Estimation
❖ Concept of Production Function
❖ Cobb and Douglas Production Function
❖ Law of variable proportion/Law of Returns/Production function with one variable
input factor/Law of Diminishing Returns
❖ Isoquants,Isocosts, Least Cost combinations of Input factors,MRTS
❖ Returns to Scale/Production function with Multiple Variable Input factors
❖ Economies of Scale & diseconomies of scale

MEANING OF COST: Cost may be defined as the monetary value of all sacrifices made to
achieve an objective i.e. to produce goods and services. Cost are very important in business
decision making. Cost of production provides the floor to pricing. It helps manager to take
correct decision, such as what price to quote, whether to place particular order for inputs or not
whether to abandon or add a product to the existing product line and so on.

Ordinarily, cost refer to the money expenses incurred by a firm in the production process. Cost
also included imputed value of the entrepreneur’s own resources and services, as well as salary
of the owner-manager.

COST CONCEPT-

The concept of cost is central to business decision making. To make effective business
decisions, the business manager needs to be aware of a number of cost concepts and their
respective uses.

Actual cost- Actual cost means the actual expenditure incurred on producing goods and
services. Value of raw material, wages, rent, salaries paid and interest of borrowed
capital etc. are some of the example of actual cost. Actual cost is also known as absolute
cost or out lay cost or money cost.

Opportunity Cost- The opportunity cost is measured in terms of the forgone benefits
from the next best alternative use of a given resource. For example the inputs which are
used to manufacture a car may also be used in the productions of military equipment.
Main points of opportunity cost are:

1. The opportunity cost of any commodity is only the next best alternative forgone.
2. The next best alternative commodity that could be produced with the same
value of the factors, which are more or less the same.
 3. It helps in determining relative prices of factor inputs at different places.

4. It helps in determining the remuneration to services.

5. It helps the manager to decide what he should produce in the factory.

Explicit cost- An explicit cost is a cost that is directly incurred by the firm, company or
organization during the production. The explicit cost is kept on record by the accountant
of the firm. Salaries, wages, rent, raw material are few example of the explicit cost. The
explicit cost is also known as out- pocket cost. This cost is handy in calculating both
accounting and economic profit.

Implicit cost- The implicit cost is directly opposite to it, as it is the cost that is not directly
incurred by the firm or company. In implicit cost outflow of cash doesn’t take place. It is
not in the record and is heard to be traced back. The interest on owner’s capital or the salary
of the owner is the prominent example of the implicit cost. The implicit cost is also known
as imputed cost. Through implicit cost , only the economic profit is calculated.

Incremental cost- Incremental costs are the added costs of a change in the level of production
or the nature of activity. It may be adding a new product or changing distribution channel, or
adding new machinery, etc. It appears to be similar to marginal cost, but it is not managerial
cost. Marginal cost refers to the cost on added unit of output.

Sunk Cost- Sunk costs are costs which cannot be altered in any way. Sunk costs are costs which
have already been uncured. For example, cost incurred in constructing a factory. When the
factory building is constructed cost have already been incurred. The building has to be used for
which originally envisaged. It can not be altered when operation are increased or decreased .
Investment of machinery is an example of sunk cost.

Shutdown cost- Shutdown cost are those cost which would be incurred in the event of
suspension of plant operations and which could be saved if operati
Were continued. For example cost of sheltering the plant equipment and construction of sheds
for protecting the exposed property, or fixed cost and maintenance cost etc.

Abandonment cost- Abandonment cost are those cost which are incurred for the complete
removal of the fixed asset from use. These may occur due to obsolesce or due to improvisation
of the firm. Abandonment costs thus involve problem of disposal of the asset.

Book cost – Book cost are those business cost which don’t involve any cash payment is made
but a provision is made in the books of accounts in order to include them in the profit and loss
account and take tax advantages.

Out of pocket cost- Out of pocket cost are those costs or expenses which are current payments
to the outsiders of the firm. All the explicit costs fall into the category of out of pocket costs.

Past cost- Past costs are actual costs incurred in the past. These costs are mentioned in the
financial accounts. , since the past costs have already been incurred, and there is no scope for
managerial decision. If the management finds out that the past costs are excessive, it cannot do
anything to rectify it now.

Future cost- Future costs are those costs which are to be incurred in the near future. This is only
a forecast. Future costs matter for managerial decisions because, the management can evaluate
the desirability of that expenditure. In the case of future costs, if the management considers them
very high , it can either reduce them or postpone the use of them.

Direct cost-Direct costs are related to a specific process or product. They are also called
traceable costs as we can directly trace them to a particular activity, product or process. They
can vary with changes in the activity or product. Examples of direct costs include manufacturing
costs relating to production, customer acquisition costs pertaining to sales, etc.

Indirect costs- Indirect costs, or untraceable costs, are those which do not directly relate to a
specific activity or component of the business. For example, an
increase in charges of electricity or taxes payable on income. Although we cannot trace indirect
costs, they are important because they affect overall profitability.

Fixed Cost- Fixed cost are the amount spent by the firm on fixed inputs in the short run. Fixed
cost are thus, those costs which remain constant, irrespective of the level of output. These costs
remain unchanged even if the output of the firm is nil. Fixed costs therefore, are known as
Supplementary costs or Overhead costs.

Variable Costs- Variable costs are those cost that change directly as the volume of output
changes. As the production increases variable cost also increases, and as the product decreases
variable costs also decreases, and when the production stops variable cost is zero.

Semi Variable Cost- This type of cost lies in between fixed and variable cost. It is neither
perfectly variable nor perfectly fixed in relation to changes in output. This type of costs include
a portion of fixed cost and a portion of variable cost, this is known as semi variable cost. For
example- electricity bill generally include both a fixed charge (meter rent) and a variable
charge(charge based on units consumed) and the total payment made is semi variable cost.
Stair Step Cost- Certain expenses increase in a stair step manner, i.e. remaining constant over a
range of output but rising suddenly to a new higher level as output passes beyond. The given
level. For example- up to a point the attendants salary may remain fixed as output increases but
beyond that point further increase in output may require an additional attendant leading to a
sudden jump in supervision expenses.

Total cost-Total cost is the total expenditure incurred in the production of goods and services.

TC= TFC+TVC

Average cost- Average cost is not actual cost, It is obtained by dividing the total cost by the total
output.

AC= Total Cost/Units Produced

Marginal cost- The cost incurred on producing one additional unit of commodity is known as
marginal cost. Thus it shown a change in total cost when one more or less unit is produced.
Short run cost- Short run is a period where the time is too short to expand the size of industry
and the increased demand has to be met within the existing size of industry because there are
certain factors which cannot be changed in short run. So short run costs are those which vary
with output when fixed plant a capital equipments remain unchanged.

Long run costs- In the long run the size of an industry can be expanded to meet the increased
demand for products such as in long run all the factors of production can be increased according
to need. Hence long run costs are those which vary with output when all input factors including
plants equipment vary.

Cost output relationship in short run-

In the short-run a change in output is possible only by making changes in the variable inputs
like raw materials, labour etc. Inputs like land and buildings, plant and machinery etc. are fixed
in the short-run. It means that short-run is a period not sufficient enough to expand the quantity
of fixed inputs. Thus Total Cost (TC) in the short-run is composed of two elements – Total
Fixed Cost (TFC) and Total Variable Cost (TVC).

TFC remains the same throughout the period and is not influenced by the level of
activity. The firm will continue to incur these costs even if the firm is temporarily shut down.
Even though TFC remains the same fixed cost per unit varies with changes in the level of output.
On the other hand TVC increases with increase in the level of activity, and decreases
with decrease in the level of activity. If the firm is shut down, there are no variable costs. Even
though TVC is variable, variable cost per unit is constant.
So in the short-run an increase in TC implies an increase in TVC only. Thus:

TC = TFC + TVC
TFC = TC – TVC
TVC = TC – TFC
TC = TFC when the output is zero.
The graph below shows Short-run cost output relationship.
In the graph X-axis measures output and Y-axis measures cost. TFC is a straight line parallel to
X-axis, because TFC does not change with increase in output.
TVC curve is upward rising from the origin because TVC is
zero when there is no production and increases as production increases. The shape of TVC curve
depends upon the productivity of the variable factors. The TVC curve above assumes the Law
of Variable Proportions, which operates in the short-run.
TC curve is also upward rising not from the origin but from the TFC line. This is
because even if there is no production the TC is equal to TFC.
It should be noted that the vertical distance between the TVC curve and TC curve is
constant throughout because the distance represents the amount of fixed cost which remains
constant. Hence TC curve has the same pattern of behavior as TVC curve.

Short-run Average Cost and Marginal Cost

The concept of cost becomes more meaningful when they are expressed in terms of per
unit cost. Cost per unit can be computed with reference to fixed cost, variable cost, total cost
and marginal cost.

The following Table and diagram illustrates cost output relationship in the short-run, with
reference to different concepts of cost.
 Cost output relationship in the long run-

In order to study the cost output relationship in the long run it is necessary to know the meaning
of long run. As known in the long run the size of an industry can be expanded to meet the
increased demand for products as such in the long run all the factors of production can be varied
according to the need. Hence long run costs are those which vary with output when all the input
factors including plant and equipment vary.

As per the above figure suppose that at a given time the firms operate under plant SAC2 and
produces output OQ. If the firm decides to produce output OR and continues with the current
plant SAC2 its average cost will be uR. But if the firm decides to increase the size of the plant
to plant SAC3 its average cost of producing OR output would then be TR. Since cost TR is less
than the cost on old plant uR, therefore new plant SAC3 is preferable and should be adopted.
Thus the long run cost of producing OR output will be TR which can be obtained by increasing
the plant size.
 Features of LAC curve

To draw long run average cost curve(LAC) we start with a number of short run average
cost(SAC) curves, each such curve representing a particular size of plant including the optimum
plant. One can now draw a LAC curve which is tangential to all SAC curves. In this connection
following features are highlighted:
1- The LAC curve envelopes the SAC curves and is therefore called as envelope curve.
2- Each point of the LAC is a point of tangency with the corresponding SAC curve.
3- The points of tangency on the falling part of SAC curve for points lying to the left of
minimum point of LAC.
4- The points of tangency occur on the rising part of the SAC curves for the points lying to
the right of minimum point of LAC.
5- The optimum scale of plant is a term applied to the most efficient of all scales of plants
available. This scale of plant is the one whose SAC curve forms the minimum point of
LAC curve. It is SAC3 in our case which is tangent to LAC curve at its minimum point
at R.
6- Both LAC ad SAC curves are U shaped but the difference between the two U shapes is
that the U shape of the LAC curve is flatter or lesser pronounced from bottom. The main
reason for this is that in the long run such economies are possible which cannot be had
in the short run, likewise some of the diseconomies which are faced in short run may not
be faced in the long run.

COST ESTIMATION
Definition
Cost Estimation is a statement that gives the value of the cost incurred in the manufacturing of
finished goods. Cost estimation helps in fixing the selling price of the final product after charging
appropriate overheads and allowing a certain margin for profits. It also helps in Inventory Reports
drawing conclusions regarding the cost of production and in determining the necessity to introduce
cost reduction techniques in order to improve the manufacturing process.

Cost estimation takes into consideration all expenditure involved in the design and manufacturing
along with all related service facilities such as machines setting; tool making as well as a portion
of sales marketing and administrative expenses or what we call overhead costs.
Example and Methods
Isn’t it absolutely annoying to pay expenses each month, without knowing the amount that you’re
going to write the cheque for? Being able to estimate business costs accurately can help you plan
for the future and see trouble on the horizon. There are many ways to estimate costs, and each one
is a different blend of difficulty and accuracy. Knowing some of these basic methods may help
you choose the right one for your firm.

Least Squares Regression

A perfect amalgamation of accuracy and ease of use, least squares regression, analyses past data
using mathematical estimation, to determine the variable and fixed components of a cost and
provides an equation that can be used to predict future expenses. While this sounds complicated,
the mathematics are built into most commercial spreadsheet programs, so adoption is as simple as
entering your bill history and clicking a few buttons.

High-Low Method
This is a quick and an easy way to estimate costs that still hold accuracy. This method takes into
consideration the highest and lowest levels of activity to calculate the fixed and variable
components of the cist, but also ignore all the data that isn’t on the extremes. If the highest and
lowest levels of expense are representative of the costs you are estimating, then you're in good
shape. If not, this method can overestimate or underestimate costs.

Scattergraph
Another quick and easy method to estimate costs is the Scattergraph method. While it might be
the quickest and the easiest method to get your expenses estimates, the values derived post
calculations might not be that accurate. To use the scattergraph method, you simply plot the cost
vs. the level of activity on a graph and draw what you think is the best-fit line through the points.
Once you've determined the best-fit line, the slope of the line is the variable cost per unit, and the
fixed cost is the point where the line crosses the y-axis. The problem with the scattergraph method
is that each person has a different idea of how to draw the best-fit line, giving each person a
somewhat different estimate of the cost.

Statistical Modelling
For the largest of small businesses, statistical modelling can be a very accurate method of cost
estimation. Industry-specific models are able to predict such complex variables in cost
computations as hotel vacancy, food costs, and stock-based compensation expense. While these
methods can be very accurate, the cost of implementation can be high, which puts them out of
reach for many small firms.

While all these methods might cater to different models, with TallyPrime you need not worry
about which method to use to calculate your cost estimates. Our cutting-edge technology and
simple reports give you a consolidated estimation of each inventory at one go.
To view the cost estimation of a particular finished product, select the relevant Stock Group which
will display the stock consumption details and cost thereof for each of the stock items falling under
that Group. Cost estimation, however, is easier said than done. An accurate estimation method can
be the difference between a successful plan and a failed one.

Concept of Production Function:

Samuelson defines the Production Function as the Technical Relationship which reveals the
technical relationship which reveals the maximum amount of output capable of being produced by
each and every set of inputs.
Production Function as that function which defines the maximum amount of output that can be
produced with given set of inputs.
Input, Output relationship – Production function
The Input for any Product or Service is called Land, Labour, Capital, Organization,
Technology
Mathematically, it is expressed as
Q = f(L1, L2, C, O, T)
Where
Q = Quantity of Production
L1 = Land
L2 = Labour
C = Capital
O –Organization
T – Technology

Cobb – Douglas Production Function:

Cobb and Douglas put forth a production function relating output in American manufacturing
industries from 1899 to 1922 to labour and capital inputs.
It is developed by Cobb and Douglas in 1924 – 26 studied manufactured Units in USA.

P = Total Output P = bLaC1-a

L= the index of employment of labour in manufacturing
C= index of fixed capital in manufacturing.
The exponents a and 1-a are the elasticity’s of production. These measures the percentage response
of output to percentage changes in labour and capital respectively.
The function estimated for the USA by Cobb and Douglas is
P = 1.01L0.75 C0.25
R2 = 0.9409
The production function shows that one percent change in labour input, capital remaining the same,
is associated with 0.75 percent change in output.
Similarly, one percent change in capital, labour remaining the same is, is associated with a 0.25
percent change in output.
The Coefficient of determination (R2) means that 94 percent of the variations on the dependent
variable (P) were accounted for by the variations in the independent variable (L AND C).
It indicates constant returns to scale which means that there is no economics or diseconomies of
large scale of production.

CES Production Function:

The below mentioned article provides a close view on the CES Production Function.
Arrow, Chenery, Minhas and Solow in their new famous paper of 1961 developed the Constant
Elasticity of Substitution (CES) function. This function consists of three variables Q, С and L, and
three parameters A, and.

It may be expressed in the form:

Q = A [aC-θ+ (l-α)L-θ] -1/θ

Where Q is the total output, С is capital, and L is labour. A is the efficiency parameter indicating
the state of technology and organisational aspects of production.

It shows that with technological and/or organisational changes, the efficiency parameter leads to
a shift in the production function, α (alpha) is the distribution parameter or capital intensity factor
coefficient concerned with the relative factor shares in the total output, and θ (theta) is the
substitution parameter which determines the elasticity of substitution.

Production Function with One variable input factor or Law of Variable Proportion or Law
of Returns or Law of Diminishing Returns or Relationship between TP, AP, MP
Law of Returns states that when at least one factor of Production is vary and then all other factors
are fixed.
The Total Output will increase at an increasing rate after reaching certain level of output;
it will increase at declining rate.
If the variable factor inputs are added further to fixed factor input, the total output may
decline and the marginal product of labour is negative.
The Law of returns is also called Law of Variable Proportions or Law of diminishing
returns.

Output with fixed Capital and Variable Labour input

Units of
TP MP AP Stages
Labour
0 0 0 0
1 10 10 10 Stage – I
2 22 12 11
3 33 11 11
4 40 7 10
Stage – II
5 45 5 9
6 48 3 8
7 48 0 6.8
8 45 -3 5.6 Stage – III

TP = Total Product
MP = Marginal Product
AP = Average Product

In Short run it is assumed that capital is fixed and labour is variable input. In the initial stages,
output increases at an increasing rate because capital is grossly underutilized. Productivity will
increase upto Point A when more and more inputs of Labour are increased.
After Point A, output increases at a declining rate till it reaches maximum at Point C.
After Point C, the total output declines and the marginal product of labour is negative.
This indicates that the additional unit of labour are not contributing anything positively to the Total
Output.

Isoquants
Iso means equal, quant means quantity. Isoquant means equal quantity or
That the quantities throughout a given isoquant are equal.
An Isoquant shows various combinations of two input factors such as Capital and Labour which
yield the same level of output.
Combinations Capital(In Lakhs) Labour Output
A 1 20 20,000
B 2 15 20,000
C 3 11 20,000
D 4 8 20,000
E 5 6 20,000
F 6 5 20,000

According to graph it shows different combinations of input factors yield an output 20,000 units.
As the Investment goes up the number of labors can be reduced.
The combination of A shows 1 unit of Capital and 20 units of labour product 20,000 units of
Output.
All the above combinations of input can be plotted on a graph the locus of all the possible
combinations of input shows up an isoquant as shown in graph.

Features of an Isograph:
● Downward Sloping: Isoquants are downward sloping curves because, if one input
increases, the other one decreases. There is no question of increase in both the inputs to
yield a given output. Isoquant slopes from left to right
● Convex to origin: Isoquants are convex to origin. It is because the input factors are not
perfect substitutes. One input factor can be substituted by other input factor in diminishing
marginal rate.
 ● Donot intersect: Two isoproducts do not intersect with each other. It is because each of
these denotes a particular level of output.
● Do not touch the axis: The isoquant touches neither X-axis nor Y-axis as both inputs are
required to produce a given product.
Isocost
Isocost representing different level of total cost. Isocost refers to that cost curve represents the
combination of input that we cost the producer the same amount of the money in other words each
isocost denotes a particular level of total cost for given level of production. If the level of total cost
for given level of production changes the total cost changes.

2.0

1.5
Capital
1.0

Labour
Least Cost Combination of Inputs
The Manufacturer has to produce at lower cost to attain higher profits. The Isocost and Isoquants
can be used to determine the input usage that minimizes the cost of Production. Where the scope
of Isoquant is equal to that of Isocost. There lies in lowest point of cost of production.
MRTS:
Marginal rate of technical substitution (MRTS) refers to the rate at which one input factor is
substituted with other to attain a given level of output.
In other words the lesser units of one input must be compensated by increasing amounts of another
input to produce the same level of output.
The below table presents the ration of MRTS between the two input factors ,say Capital & Labour.
5 units of decrease in labour are compensated by an increase in 1 unit of capital, resulting in a
MRTS of 5:1
Combinations Capital(In Lakhs) Labour MRTS
A 1 20
B 2 15 5:1
C 3 11 4:1
D 4 8 3:1
E 5 6 2:1
F 6 5 1:1

Production Function with all variable input factors or concept of returns to scale:
Returns to Scale refers to the Profits enjoyed by firm as a result of change in all the inputs.
There are three phases under returns to scale
1. Law of increasing returns to scale
2. Law of constant returns to scale
3. Law of decreasing returns to scale
Law of Increasing Returns to Scale
The law states that the volume of output keeps on increasing with every increase in the inputs
where a given increase in input leads to a more than proportionate increase in the output, the law
of increasing returns to scale is said to operate.
Law of Constant Returns to scale
It is said to operate when the rate of increase/decrease in volume of output is same to the rate of
increase/decrease of Inputs.
Law of Decreasing Returns to scale
Law of Decreasing returns to scale states that where the proportionate increase in the inputs does
not lead equivalent increase in output. The Output increases at declining rate. The law of
decreasing returns to scale is said to operate.
For example:
Capital Labour Output
Percentage Increase Percentage
(In (In (In Law applications
in both inputs Increase in Output
units) units) units)
1 3 50 50
Law of Increasing
2 6 100 120 140
Returns
Law of Constant
4 12 100 240 100
Returns
 Law of
8 24 100 360 50 Decreasing
Returns

From the above table, it is clear with one unit of capital and three units of labour, the firm produces
50 units of output
When inputs are doubled i.e. 2 units of capital and 6 units of labour, the output has gone up 120
units (from 50 to 120).
Thus, inputs are increased by 100%, the output has increased by 140% that is output has increased
more than doubled this is governed by law of increasing returns to scale.
When the inputs are further doubled i.e. Four units of capital and 12 units of Labour. The output
has gone up to 240 units (from 120 to 240)
Thus, when inputs are increased by 100% the output has increased by 100% i.e. output also has
doubled. This is governed law of constant returns to scale.
When the inputs are further doubled i.e. 8 units of capital and 24 units of labour the output has
gone up 360 units (from 240 to 360)
Thus, when inputs are increased by 100%, the Output increased only by 50%. This is governed
Law of decreasing returns to scale.

Economies of Scale:
It is classified into Two types
1. Internal Economies
2. External Economies
Internal Economies
● Managerial Economies: As the firm expands, it needs qualified managerial personnel to
handle each of its functions such as Marketing, Finance, Production, Human Resources
and others in a professional way.
● Commercial Economies: The Transactions of buying and selling raw materials will be
rapid and the volume of each transaction also grows as the firms grow.
● Technical Economies: Increase in the scale of Production follows when there is
sophisticated technology available and the firm is in a position to qualify technical man
power to make use of it.
● Marketing Economies: As the firm grows larger and larger, it can afford to maintain a full-
fledged marketing department independently to handle the issues related to promotion
campaign, handling of sales, launching a new product
● Risk Baring Economies: As there is a growth in the size of the firm, there is increase in the
risk also. Sharing the risk with the insurance company is first priority for any firm. The
firm can insure its Machinery and other assets against the hazards, fire, theft, other risks.
● Economies of Research and Development:Large organizations such as Dr. Reddy’s lab,
spend heavy on research and development and bring out several innovative products. Only
such firms with strong R&D base can cope with competition globally.
External Economies
● Economies of Concentration: Because all the firms are located at one place, it is likely that
there is a better infrastructure in terms of roads, transportation facilities such as railway
lines, banking and communications facilities, availability of skilled labour and such
factors.
● Economies of Welfare: There could be common facilities such as Canteen, industrial
housing, community halls, schools and colleges, hospitals and consumer stores which can
be used in common by the employees in whole industry.
● Economies of Research and Development: All the firms can pool resources together to
finance research and development activities and those share the benefits of research.
Diseconomies of scale
DISECONOMIES OF LARGE SCALE PRODUCTION

Internal and external diseconomies are the limits to large-scale production. It is possible that
expansion of a firm’s output may lead to rise in costs and thus result diseconomies instead of
economies. When a firm expands beyond proper limits, it is beyond the capacity of the manager
to manage it efficiently. This is an example of an internal diseconomy. In the same manner, the
expansion of an industry may result in diseconomies, which may be called external diseconomies.
Employment of additional factors of production becomes less efficient and they are obtained at a
higher cost. It is in this way that external diseconomies result as an industry expands.

The major diseconomies of large-scale production are discussed below:

Internal Diseconomies:

A). Financial Diseconomies:

For expanding business, the entrepreneur needs finance. But finance may not be easily available
in the required amount at the appropriate time. Lack of finance retards the production plans thereby
increasing costs of the firm.

B). Managerial diseconomies:

There are difficulties of large-scale management. Supervision becomes a difficult job. Workers do
not work efficiently, wastages arise, decision-making becomes difficult, coordination between
workers and management disappears and production costs increase.

C). Marketing Diseconomies:

As business is expanded, prices of the factors of production will rise. The cost will therefore rise.
Raw materials may not be available in sufficient quantities due to their scarcities. Additional
output may depress the price in the market. The demand for the products may fall as a result of
changes in tastes and preferences of the people. Hence cost will exceed the revenue.
D). Technical Diseconomies:

There is a limit to the division of labour and splitting down of production processes. The firm may
fail to operate its plant to its maximum capacity. As a result cost per unit increases. Internal
diseconomies follow.

E). Diseconomies of Risk-taking:

As the scale of production of a firm expands risks also increase with it. Wrong decision by the
management may adversely affect production. In large firms are affected by any disaster, natural
or human, the economy will be put to strains.

External Diseconomies:

When many firm get located at a particular place, the costs of transportation increases due to
congestion. The firms have to face considerable delays in getting raw materials and sending
finished products to the marketing centers. The localization of industries may lead to scarcity of
raw material, shortage of various factors of production like labour and capital, shortage of power,
finance and equipments. All such external diseconomies tend to raise cost per unit.