Since cost of production is the money value of all direct and indirect expenses made on hiring and purchasing of inputs that are used in producing a given quantity of output, the skills and quantities of these inputs combined with the efficiency with which these inputs are managed, environmental factors affect the cost of production. Some of these factors are as below:
Level of Output. The level of output or the quantity produced has a direct relationship with cost of production. The larger the quantity produces, the greater is the amount of inputs used and hence higher are the expenses on inputs.
Input Prices: Besides quantity of inputs used, the prices of inputs have a bearing on production costs. Increase in wages or upward revision of power rates are bound to increase cost of production. Increase in prices of petroleum products that are used as energy sources in industry and transport has been responsible for increase in cost and prices of goods in recent times.
Laws of Returns: We have discussed in an earlier chapter the laws of increasing and diminishing returns in production. Increasing returns means output increases more than proportionately in response to the increase in input. With input prices remaining constant, that every additional expenditure on an extra unit of input will bring about these additional units, that would in turn, cause some decline in the overall costs of production. Conversely, if proportionate increase in production in response to an increase in input and hence cause a faster increase in cost. In other words, the cost of production is deeply affected by whether the firm is operating under conditions of diminishing costs (increasing returns) or increasing costs (diminishing returns) in its production operations.
State of Technology: Cost of production also depends upon the state of technology. The modern automated production method or the state of the art machinery may means an initial large expenditure, but the amount of output it produces per unit of time is so large as to affect a substantial reduction in cost of production. On the other hand, the old and outdated production method or the obsolete technology used in most of the India’s small scale industries results in a high cost. It is a common knowledge that khadi mill made cloth produced with traditional technology is far more costlier than mill made cloth produced with latest machinery.
Size of the Plant: Plant size and scale of operations too affect the cost production. Small size of plant may not be able to use the modern sophisticated technology either because the firm cannot afford to buy it or it finds it unviable due to small demand for its product. But the bigger plants not only use these most modern production method but they also reap the economies of large scale production. This brings down their production costs. This is the reason why India’s traditional small scale business and industries cannot stand the competition of low cost high quality products of modern industries and goods imported from the advanced industrial nations.
Managerial Efficiency: Managerial efficiency is the key to business efficiency and cost management. The key management functions relate to decision making, coordition and motivation. An efficient management takes correct and consistent decisions about production, purchases, sales, transportation, etc. in a manner that no workers remain idle at any time, no crucial inputs are out of stock and obstruct production, and no unnecessary inventories pile up in the godowns. This naturally helps to reduce costs. Similarly, an efficient management keeps the workers adequately motivated through a system of incentives, promotions, healthy work environments, proper breaks in working hours, etc. this is the way most of the foreign companies and multinational corporations work and produce, get the best from their employees and also minimize their costs. This is in contrast to inefficient, uninterested and unaccountable management of most of the public sector enterprises in India working with an undisciplined, demotivated and indifferent staff.
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