RETURNS TO SCALE IN CARPET INDUSTRY IN

UNITED STATES

Submitted to:Prof. Renu Verma

Submitted by:

Angad Singh KalraNidhi SharmaReema KharbandaSahil KukrejaShivani GroverShubham JainSumit Gugnani

RETURNS TO SCALE

In production returns to scale refers to changes in output subsequent to a proportionalchange in all inputs. ( where all inputs increase by a constant factor)

It is a long run production function P = f (m L, m K, m T……..)

TYPES OF RETURNS TO SCALE

INCREASING RETURNS TO SCALE

CONSTANT RETURNS TO SCALE

DIMINISHING RETURNS TO SCALE

INCREASING RETURNS TO SCALE

It refers to the production situation where if all factors of production are increased in a given proportion , output increases in a greater proportion.Thus, if by 100% increase in factors of production , output increases by 120% , it will bean instance of INCREASING RETURNS TO SCALE.

Labor (hours)

Capital(machine

hours)

10

20

30

5 10

2

4

0

A

CONSTANT RETURNS TO SCALE

It refers to that production situation where if all factors of productionare increased In a given proportion, the output produced increases inexactly the same proportion.

If 25% increase in labour and capital is followed by 25% increase in output, then it is an instance of CONSTANT RETURNS TO SCALE.

Constant Returns to Scale

Labor (hours)

Capital(machine

hours)

10

20

30

155 10

2

4

0

A

6

DIMINISING RETURNS TO SCALE

It refers to that production function where if all the factors of production are increased In a given proportion , the output increases in a smaller proportion.If 20% increase in labour is followed by 10% increase in output, then it is the case of DIMINISHING RETURNS TO SCALE

Returns to Scale

Labor (hours)

Capital(machine

hours)

Decreasing Returns:Isoquants get further apart

1015

20

5 15

2

6

0

A

REASONS FOR DIMINISHING RETURNSTO SCALE

PRODUCTION BEYOND OPTIMUM CAPACITY

UNWISELY MANAGEMENT

NON AVAILABILITY OF INPUTS

Economies of ScaleWhen more units of a good or a service can be produced on a larger scale, with less input costs, economies of scale are said to be achieved. Alternatively, this means that as a company grows and production units increase, a company will have a better chance to decrease its costs. According to theory, economic growth may be achieved when economies of scale are realized. 

Division of labour and specialization are the two key means to achieve a larger return on production.

Through these two techniques, employees would not only be able to concentrate on a specific task, but with time, improve the skills necessary to perform their jobs. The tasks could then be performed better and faster. Hence, through such efficiency, time and money could be saved while production levels increased.

Internal and External Economies of Scale

Alfred Marshall made a distinction between internal and external economies of scale. When a company reduces costs and increases production, internal economies of scale have been achieved. External economies of scale occur outside of a firm, within an industry. Thus, when an industry's scope of operations expands due to, for example, the creation of a better transportation network, resulting in a subsequent decrease in cost for a company working within that industry, external economies of scale are said to have been achieved. With external ES, all firms within the industry will benefit

Economies of scale and returns to scale

• Where economies of scale refer to a firm's costs, returns to scale describe the relationship between inputs and outputs in a long-run (all inputs variable) production function. A production function has constant returns to scale if increasing all inputs by some proportion results in output increasing by that same proportion. Returns are decreasing if, say, doubling inputs results in less than double the output, and increasing if more than double the output.

Diseconomies Of Scale

• What Does Diseconomies Of Scale Mean?An economic concept referring to a situation in which economies of scale no longer function for a firm. Rather than experiencing continued decreasing costs per increase in output, firms see an increase in marginal cost when output is increased.

Causes for diseconomies of scales

CONCEPT OF RETURNS TO SCALE ILLUSTRATED WITH THE HELP OF

TPP SCHEDULE

Input Combination

TPP (Units)

% increase in inputs

% increase in outputs

Description

1K + 2L 5 - - IRS

2K + 4L 11 100% 120% IRS

3K + 6L 18 50% 63.63% IRS

4K + 8L 24 33.3% 33.33% CRS

5K + 10L 30 25% 25% CRS

6K + 12L 35 20% 16.66% DRS

7K + 14L 40 16.6% 14.28% DRS

CONCEPT OF RETURNS TO SCALE ILLUSTRATED WITH THE HELP OF SINGLE PRODUCTION FUNCTION

Suppose our production function is as follows:

Q = f (L ,K)

This production function tells us that the firm produces Q output with the help of L units of labor and K units of capital.

Now suppose , that the firm increases amount of L and K factors “t” (t > 1) times then the new output level will be :

Q1 = f ( tL , tK)

now there can be 3 possibilities :

i) If the new output level is greater than “t” times the previous level of output , the production function exhibits increasing returns to scale . So , mathematically :

f ( tL , tK) > t . f (L ,K) ; for all t > 1

ii) If the new output level is equal to “t” times the previous level of output , the production function exhibits constants returns to scale . So , mathematically :

f ( tL , tK) = t . f (L ,K) ; for all t > 1

iii) If the new output level is less than “t” times the previous level of output , the production function exhibits diminishing returns to scale . So , mathematically :

f ( tL , tK) < t . f (L ,K) ; for all t > 1

COBB – DOUGLAS PRODUCTION FUNCTION

The Cobb – Douglas production function is given by :

Q = A L α . K β ; where α and β are constants.

if we increase both the inputs ( t > 1 ) times , we get the new output as

Q1 = (tL)α (tK)β = t α+β Lα Kβ

• when , α + β = 1 we have Q = t . Q1 . So the production function exhibits Constant Returns to Scale.

• when α + β > 1 , the production function exhibits Increasing Returns To Scale.

• when α + β < 1 , the production function exhibits Decreasing Returns To Scale.

TOTAL COST AND AVERAGE COST IN RETURNS TO SCALE

History of Carpet Industry

The US Carpet industry would begin in 1791 when William Sprague opened the first woven carpet mill in Philadelphia.

In 1839 , Erastus Bigelow revolutionized the carpet industry when he invented the power loom

Along the woven carpet industry ,The tufted carpet industry started in Dalton, Georgia and grew progressively to influence the whole of the state and then, the whole of the nation

In 1930s, the first machine that produced tufted bedspreads was developed. . Within few decades, demand had increased to millions, and the town of Dalton experienced immense development of infrastructure and facilities to support the thriving industry

By the late 1940s this array of tufted-textile consumer goods produced annual sales of more than $50 million.

New Technology : A carpet tufting machine

•Around 1950 old spread-making firms like Cabin Crafts and brand new maverick companies like E. T. Barwick Mills began using tufting machines.

•A tufted cotton carpet sold for about half the cost of a similar woven wool product

..

•Cotton carpets were of poorer quality Du Pont helped the new industry solve this problem by introducing bulked continuous filament (BCF) nylon in 1957.

The Gold Coast: Growth in the 1960s

Tufting and nylon opened up vast new markets for carpet. The old woven manufacturers had long complained about the slow growth of their industry; per capita carpet consumption in 1950 was about the same as it had been two decades earlier.

Carpet consumption followed the price trend. As tufted goods brought down prices, consumers covered more and more floor space with carpets

Carpet industry sales topped $1 billion annually in the early 1960s and surpassed $2 billion in the early 1970s

The carpet industry became the fourth-fastest-growing industry in the United States during the 1960s, surpassed only by television picture tubes, aircraft, and computers. The number of competitors in the carpet industry grew from 88 in 1958 to more than 400 by the late 1970s, with a majority of those firms located in Georgia

Present Scenario in Carpet Industry• Total industry shipments in 2010 totaled 1.6 billion square yards (14.4 billion

square feet). (In 1940, industry shipments were 50 million square yards.)

• In the present scenario, the role of carpets in interior decoration of business establishments and houses has significantly increased. This guided choice for floor covering is emerging as the main propellant for the industry’s sales.

• The year 2009 represented a challenging year for the global carpet market on account of general recession worldwide, and specifically due to decline in housing and commercial sector and low confidence and spending levels of consumers.

• The recession also severely affected carpet exports and general well being of the weavers. The industry's mechanization and automation processes rendered a large number of artisans unemployed and dependent on market vagaries.

Present Scenario in Carpet Industry• The tufted carpet segment constitutes the largest category,

accounting for a lion’s share of the market. The segment commands the leading position primarily on the strength of ease of manufacturing, comparable design features and low costs.

• On the other hand, the woven carpet segment is forecast to drive future growth in the industry. Major attractions of woven carpets include rich color palette, intricate patterning and design flexibility among others.

• The major participants in the handmade carpet industry include Pakistan, Afghanistan, India, China, England, France, Russia, the US and Persian countries.

Present Scenario in Carpet Industry

• In present scenario USA and Germany still continues to hold their top position in the table of 2009,

• market is now globalised which shows new trends in carpet consumption and potential of different countries to be a big market in the future .

Introduction to the Case:Returns to Scale in Carpet Industry

The carpet industry in United States is located around the town of Dalton in northern Georgia, Atlanta.

Grew rapidly and became a major industry with large number of firms of all sizes.

Was a relatively small firm in the first half of twentieth century.

There are relatively three large manufacturers:o Shaw,o Mohawk,o Beaulieu.

The top five manufacturers ranked according to their shipment in millions of dollars in 2005 are:

T h e U. S . C a r p e t I n d u s t r y

ManufacturersSales (Millions of dollars per year)

2005 2001 1996

1. Shaw 4346 4012 3202

2. Mohawk 3779 3350 1795

3. Beaulieu 1115 1300 1006

4. Interface 421 639.8 820

Reasons :Consumer demand:

Demand for wool, nylon, polypropylene carpets in commercial and residential uses has gone up. 

Innovations:

Introduction of larger, faster and more efficient carpet-tufting machines. 

Competition  Improvements in the processing of key production inputs (such as stain-resistant yarns)

These reasons have not only reduced costs but also greatly increased the carpet production.

Capi t a l i n t e ns i ve bus i ne s sHuge investments are required ino Tufting machines that turn yarn into carpet.o Machines that cut the carpets into appropriate sizes, and package, label, and

distribute them.Manufacturer’s cost include:o 77% physical costo 23% labor

Results

Manufacturers increased their scale of operations by installing larger and more efficient machines in larger plants.The use of labor in these plants has also increased significantly.

The result is:Large industries:Proportional increases in inputs have resulted in a more than proportional increase in the output.

increasing returns to scale.Small industries:Small proportional increases in inputs have only increased output proportionally.

constant returns to scale

Returns to Scale: Carpet Industry

The carpet industry has grown from a small industry to a large industry with some very large firms.

There are four relatively large manufacturers along with a number of smaller ones. Growth has come from:

Increased consumer demandMore efficient production reducing costsInnovation and competition have reduced real prices

Returns to Scale: Carpet Industry

– Some growth can be explained by returns to scale

– Carpet production is highly capital intensive• Heavy upfront investment in machines for carpet

production

– Increases in scale of operating have occurred by putting in larger and more efficient machines into larger plants

Returns to Scale: Carpet Industry Results

Ques: Why Large Manufacturers are enjoying increasing returns to scale?

– Large Manufacturers• Increases in machinery and labour• Doubling inputs has more than doubled output• Economies of scale exist for large producers

Returns to Scale: Carpet Industry Results

Ques: Why Small mnufacturers are having Constant Returns to Scale?

– Small Manufacturers• Small increases in scale have little or no impact on

output• Proportional increases in inputs increase output

proportionally• Constant returns to scale for small producers

Returns to Scale: Carpet Industry

Ques : Will Large Plants reach at the stage of Decreasing Returns to Scale?

– From this we can see that the carpet industry is one where: There are constant returns to scale for relatively small plants.

– There are increasing returns to scale for relatively larger plants• These are limited, however• Eventually reach decreasing returns

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