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Definition and Explanation:

Optimum firm is that firm which fully utilizes its scale of operation and produces optimum output with the minimum cost per unit of production.

Factors affecting Optimum Firm:

In the short run, a firm would build the scale of plant and operate it at a point where the average cost is at its minimum. This is regarded as the optimum level of production for the firm concerned, if the demand for the product increases from this least cost output; it cannot change the amount of land, buildings, machinery and other input in short period of time. It has to move along the same scale or type of plant. The average total cost, therefore, begins to rise due to the diseconomies of the scale.

In the long run, all inputs are variable. The firm can build larger plant sizes or revert to smaller plants to deal with the changed demand for the product. If the size of plant increases to cope with the increased demand, the average cost per unit begins to fall due to the economies of scale such as increased specialization of labor, better and greater specialization of management, efficient utilization of productive equipment, etc. So long as the resources are successfully utilized, the average cost of production continues declining.

Eventually a stage comes when the firm is not able to use the least cost combination of inputs. The building of a still larger plant cause the average cost of production to go up. The point at which the per unit cost is the lowest is the optimum level of production for the firm. The firm of the most efficient size.

Diagram:

The concept of the optimum firm can be explained with the help of the following diagram:

In the diagram (10.1) units of output are measured along OX axis and units of cost along OY axis. In this figure, there are four alternative scales of plant. SAC1, SAC2, SAC3 and SAC4.

If the anticipated output rate is OK, the firm should choose the smallest plant, SAC1. This is due to the fact that the cost per unit for OK output is lowest at point A on plant SAC1. If the anticipated output rate is OL plant SAC2 yields lowest cost per unit at point B. This is the optimum plant of the firm and is of the most efficient size. If a larger plant of the SAC3 size is constructed to meet the rising demand for the product, then the economies of the scale mainly of managerial nature arise. The per unit cost of production begins to arise. Thus the scale SAC2 represent the optimum plant and BL is the least cost output of this plant.