Optimum Size of the Firm
It is important to explain the concept of optimum firm. The optimum firm refers to the best or ideal size of the firm. More specifically optimum or best firm is considered as one that has set up a plant with lowest possible cost and is also operating it at its lowest average cost point. E.A.G. Robinson who has done a good deal of research on the issue of optimum firm writes, “an optimum firm is the one which operates at the scale at which, in the existing conditions of technique and organizing ability, has the lowest average cost of production when all those costs which must be covered in the long run are included”.
This means that optimum firm is one which operates at the lowest point of long-run average cost curve of production. Production at the minimum point of the long-run average cost curve is called optimum because at it resources of the society are most efficiently used.
When a firm expands its size to the lowest point of the long-run average cost (LAC), it sets up a plant which, given the state of technology, has the lowest unit cost of production when operated at its full capacity. As has been explained above that long-run average cost of a firm is influenced by the various economies and diseconomies of scale. These economies and diseconomies are determined by various technical, managerial, financial and marketing factors.
The optimum size is achieved when all the internal economies of scale such as division of labour, use of specialised machinery, managerial advantage of large scale production etc. are being fully enjoyed by the firm and the internal diseconomies of scale have not yet started accruing to it.
It is worth noting that in the determination of optimum size, the state of technology and methods of organizing business remain unchanged. In Fig. 1 optimum firm is one that has set up a plant represented by short-run average cost curve SAC4 and operating at the minimum point P on it and producing output OQ.
It is clear from Fig. 1 that in the continuous long-run average cost curve both for outputs less than OQ and more than OQ no plant is used at its point of minimum average cost. It is only the plant, the minimum point of whose short-run average cost curve coincides with the minimum point of the long-run average cost curve, which is operated at the point of minimum point of its short-run average cost curve. In Fig. 1 for producing output OQ, the plant of SAC4 is being utilized to produce its optimum output OQ, that is to say, it is being used at its full capacity.
It should be noted that in Fig. 1 the plant of SAC4 is optimum plant, since its minimum cost of production is the lowest of the minimum costs of all other plants. If the size of the plant is increased beyond SAC4, it results in higher average cost of production.
Similarly, if the size of the plant is smaller than SAC4, average cost of production is higher. Further, the least-cost output, or in other words, the optimum output of the plant SAC4 is OQ. Now, if the firm produces output OQ with the optimum plant SAC4, it is said to have achieved the optimum size.
Thus, an optimum firm is that firm which is producing optimum output (i.e., least-cost output) with the optimum plant. In our Fig. 1 the firm is of optimum size if it employs plant SAC4 and uses it to produce OQ. Since the point of minimum cost of the optimum plant SAC4 coincides with the minimum point of the long-run average cost curve, the optimum firm can also be defined as one which produces at the minimum point of the long-run average cost curve (LAC).
The optimum size of the firm varies a great deal in different industries. In agriculture, extractive industries, wholesale and retail trade, optimum size is relatively small, that is, the minimum point of the long-run average cost curve is reached at a comparatively small output.
Fig. 2 shows a firm whose optimum size is relatively small. On the other hand, the optimum size of the firm in steel industry, automobile industry, other heavy industries and public utilities is relatively very large, that is, the minimum point of their long-run average cost curve is reached at a relatively very large output. Fig. 3 depicts a firm whose optimum size is very large. In the industry in which the optimum size of the firm is very large, there are generally a few numbers of firms, each with a large size.