The Learning Curve

In the analysis of cost theory, we find that a large firm is likely to have lower long-run average costs than a small firm on account of increasing returns to scale in production. This may lead us to conclude that firms which have lower average costs over time are growing firms with increasing returns to scale.

However, it would be wrong to generalize that lower average costs are on account of increasing returns to scale. Empirical findings reveal that in some firms, the long-run average cost declines over time because workers, managers, and entrepreneurs easily absorb the latest technological information and thus become more experienced.

According to Pindyck and Rubinfeld, as management and workers gain experience with production, the firm’s marginal and average cost of producing a given level of output fall due to the:

1. Workers become more experienced and adept and subsequently take less time to complete the same task.
2. Managers learn to handle the production process efficiently, from the flow of raw materials to the organization of the manufacturing itself.
3. Engineers and technicians are able to cut costs by designing better products. Also, specialised and sophisticated tools and plant organization helps in lowering of costs.
4. Suppliers of inputs may learn to procure and process materials and resources more efficiently and pass the benefit to the producers.

The learning process happens over a long period of time. The firm’ learns’ to produce at a lower cost as cumulative output increases. Thus, the learning curve describes the relationship between a firm’s cumulative output and the amount of inputs required to produce each unit of output.

The above figure shows a learning curve for the production of commodity X. The X-axis measures the cumulative output of X. The Y- Axis shows the number of hours of labour needed to produce one unit of X. The labour input per unit of output directly affects the production cost because the fewer units of labour required per unit of output, the lower the marginal and average cost of production.

The learning curve is based on the relationship, L = A + BN^—β , where N is the cumulative units of output produced, L is the labour input per unit of output, A , B, and β are constants, with A and B positive, and β between 0 and 1.

When N is equal to 1, L is equal to A + B, so that A + B measure the labour input required to produce the first unit of output.

When β is equal to 0, labour input per unit of output remains the same as the cumulative level of output increases. Therefore, there is no learning.

When β is positive, and N gets larger and larger, L becomes arbitrarily close to A.A, therefore, represents the minimum labour input per unit of output after all learning has been achieved.

The larger the β is, the more significant is the learning effect. With experience, the firm’s degree of learning is higher, and this would substantially reduce production costs. In the figure, the learning curve slopes steeply until the cumulative output of 20 is reached, and beyond this output level, the reduction in cost is very less, and the learning effect is over.

Learning Curve verses Economies of Scale

In Figure 1, the cost diminishes due to the learning effect until 20 units of output are produced. The entire effect of the learning curve is exhausted after the 20 units of output. The reduction in cost after this may be entirely due to economies of scale.

In case the production process were relatively new, relatively high cost at low levels and relatively low cost at higher levels of output would indicate learning effects, not economies of scale. With learning, the cost of production for an experienced firm is generally less, regardless of the scale of the firm’s operation.

The figure3 shows that a firm’s average cost of production declines over time, and there are economies of scale in production. The firm moves from A1 to A2 along AC1. This enables the firm to lower costs. The movement from A1 to A2 is due to increasing returns to scale. However, when the firm moves from A1 on AC1 to A3 on AC2 , there is a reduction in cost on account of learning.

Significance of Learning Curve:

The learning curve plays an important role in the production plans of firms. In the present times, where competition plays a dominant role, enterprises are always in the constant process of discovering methods to produce low-cost and efficient products. The firms keep on launching new and better products time and again. As a result, the estimation of the cost of production of new products is done, and the learning curve enables the firm to proceed and produce efficiently.

According to Pindyck and Rubenfeld, ‘‘because there is a learning curve, the per unit labour requirement falls with increased production. As a result, the total labour requirement for producing more and more output increases in smaller and smaller increments. Therefore, a firm looking only at the high initial labour requirement will obtain an overly pessimistic view of the business.’’

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