It is important to note that in a smooth continuous LAC curve, no plant is operated at its minimum point of average cost. It is the plant (represented by SAC3) for which the minimum point of SAC curves coincides with the minimum point of the LAC curve at point ‘M’.
The plant represented by SAC3 is optimum size of the plant, since its minimum cost of production is the least of the minimum costs of all other plants. In other words, this plant is more efficient as compared to other plant sizes.
In the words of Eckert and Leftwich, “The optimum size of plant is the one generating the short-run average cost curve that forms the minimum point of the long-run average cost curve. It can also be thought of as that size of plant with a short run average cost curve tangent to the long-run average cost curve at the minimum points of both”.
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The optimum plant represented by SAC3 can be used at its full capacity by producing its optimum output OQ at the minimum cost of MQ. When plant is not fully utilised, it is both a physical and monetary loss. When the plant remains idle, obsolescence is likely cost just like depreciation is a cost when the plant is over utilised.
The firm producing optimum output with the optimum plant is called as optimum firm. The optimum firm can also be defined as one which produces at the minimum point of the LAC curve, given existing techniques and organising ability.
Here, the firm has no X – efficiency, i.e., production unit (monitored and controlled by production manager) is able to reduce the wastage of resources. The optimum size of the firm in agriculture and extractive industries is relatively small, i.e., the minimum point of the LAC curve is reached at a comparatively smaller output.
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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. In such industries, generally there are few large firms and the minimum point of the LAC curve is reached at a relatively larger output.
When the size of the plant is increased beyond the optimum size, it results in higher average cost. Likewise, if the size of the plant is smaller than that of optimum size, average cost of production is higher.
Often, firms are not in a position to operate at the optimum level on account of various factors:
(i) Firms, sometimes, want to hoard the stock and to create artificial scarcity so as to get higher price in the future. Such a situation arises, when there is a lack of competition in the market for the commodity.
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(ii) Firms in drive for industrial empire often produce beyond full capacity in order to keep the potential entrants out of the market. This strategy is known as market dominance strategy.
(iii) Sometimes, the Government’s regulation stipulates the level of output and the firms are forced to operate below optimum output. This is specially true of firms governed by the Monopolies and Restrictive Trade Practices Act and Industries (Development and Regulation) Act.
(iv) Sometimes, the firms keep on trying to move towards the optimal scale, but are unable to reach optimal level. This happens, when by the time, the firms make adjustments to the changes in market conditions, technology and the prices of factor inputs, other changes take place in the mean time failing them to reach at the optimal levels of output.
(v) Optimal scale is only the lowest cost scale of enterprise. It is not necessarily the most profit-able scale. The market may not be big enough to permit the firm to operate at optimal scale.