Productivity, Efficiency and Economies of Scale

Productivity is a ratio, not a total

Productivity measures output per unit of input. Labour productivity is total output divided by the number of workers (or, more precisely, by labour hours); capital productivity is output divided by the capital employed. A factory that raises total output by hiring more workers has not raised productivity at all — the ratio may even fall. IB questions exploit this gap constantly, so the safest habit is to compute the ratio explicitly rather than reason from the totals.

Efficiency and unit cost

Efficiency in operations is usually measured through unit cost (average cost per unit of output).

Unit cost falls when fixed costs are spread over more units, when waste and defects fall, or when inputs are bought more cheaply. Note that the first of these is short-run, and it is not an economy of scale.

Economies of scale

Internal economies of scale are cost advantages a firm generates itself as its scale of operation grows: purchasing (bulk-buying), technical (large indivisible equipment used fully), financial (cheaper credit for larger, safer borrowers), managerial (specialist managers whose salary is spread widely) and marketing (one campaign covering more units). External economies of scale come from the growth of the whole industry or region — a skilled local labour pool, specialist suppliers clustering nearby, better infrastructure — and they benefit every firm in the cluster, not one firm alone.

Diseconomies of scale

Beyond a certain size, unit costs rise again. The causes are human rather than technical: communication becomes slower and more distorted, coordination between divisions absorbs management time, and motivation falls as individuals feel anonymous inside a large organisation. The output level where unit cost is lowest is the minimum efficient scale.