Cost of learning curve effect: The Economics of Learning Curves: Cost Reduction Strategies

• SJ Saturday
• January 12, 2023
• Bookkeeping
• 0 Comments

It is important to note that reduction in cost per unit due to the learning curve effect is different from economies of scale. Notice from Table 2 that the unit labor hours (column 2) andunit labor cost (column 4) decrease by 20% each time the cumulative output isdoubled. However, the cumulative total labor hours (column 3) and cumulativetotal labor cost (column 5) increase by a variable rate. It also means that the cumulativetotal hours and cost generated by the two models are not compatible when basedon the same learning rate. The cumulative total hours for 8 units is 409.6 based on Wright’smodel and 534.6 based on Crawford’s model. Another difference is that thecumulative average hours and cost decrease by a variable rate in Crawford’smodel.

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Learning curves, also called experience curves, relate to the much broader subject of natural limits for resources and technologies in general. Approaching limits of perfecting things to eliminate waste meets geometrically increasing effort to make progress, and provides an environmental measure of all factors seen and unseen changing the learning experience. Perfecting things becomes ever more difficult despite increasing effort despite continuing positive, if ever diminishing, results. The same kind of slowing progress due to complications in learning also appears in the limits of useful technologies and of profitable markets applying to product life cycle management and software development cycles). Remaining market segments or remaining potential efficiencies or efficiencies are found in successively less convenient forms.

Learning Curve: An Important Modern Concept in Economics

• This percentage repre­sents the proportion by which cost per unit of output declines with the increase in cumulative output in each successive time period.
• Across the different economic frameworks, the learning curve uniformly signifies improvements in efficiency and reductions in cost through accumulated experience.
• The learning effect can lead to a learning curve – which represents how average costs of production change over time.
• An improvement in education should lead to higher productivity, though it may take considerable time.

Often a venture will not look attractive if the assumed costs of production are based on the costs that apply in the initial periods of production. In some sense, decreased profits and even losses in the initial production periods are necessary investments for a successful long-term operation. This percentage repre­sents the proportion by which cost per unit of output declines with the increase in cumulative output in each successive time period. However, if A and B maintain a price level at which firm A can endure, time per unit for A will decrease at a higher rate than B, because of the steeper slope for lower cumulative volumes of production. Therefore, the longer A stays in the market, the lower the profits for B, as it is drawn in the diagram on the right, where the difference between learning curve economics average times (from Y’A to Y’B) is smaller. Game theory and the analysis of oligopolies tell us that, since B is able to anticipate all these scenarios, firm B will try to banish firm A from the market.

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The model was widely applied during World War II (WWII) when it was realized that the cost of aircraft decreased with the increase in production performance. It was later taken up by the industrial and business sector for a variety of performance improvement applications. Using a learning curve can help a business to improve the performance and productivity of their workforce and reduce costs.

Wright’s experience curve

There are several data points to choose from, one of which is the total cumulative time needed to produce a given number of tasks or units. In the graph below, the learning curve shows that more time is needed to generate more tasks. From a technological standpoint, economies of scale can be observed in the software industry. Once a software product is developed, the cost of producing additional copies is relatively low. Thus, software companies can achieve significant economies of scale as they expand their user base. In looking at the collective performance of a production operation, we need a measure of productivity that applies to all inputs being used rather than the last unit acquired.

Keynesian Economics would interpret learning curves in the context of aggregate supply, where long-term efficiencies and cost reductions can stimulate greater production and influence macroeconomic policy decisions. The learning curve in manufacturing is a dynamic and powerful force that drives operational excellence and competitive advantage. The learning curve effect extends beyond individual and organizational learning; it has implications for strategic planning, competitive strategy, and even national policy regarding education and workforce development.

• The model can be used to determine how long it takes for a single person to master a skill or how long it takes a group of people to manufacture a product.
• For example, in agriculture an acre of land in one location may be capable of better yields than an acre in another location.
• Usually, when a product is first produced, the average cost of production is high because the first firm needs to learn by trial and error the best way to make the product.
• If the software is important for productivity, then employee performance could decrease over time if employees cannot effectively use the software.
• The doubling rate is the reduction in average cost that occurs each time cumulativeproduction doubles.

Economies of scope represent a pivotal concept in the strategic management and operational capabilities of a firm. These efficiencies can be realized through the sharing of resources, distribution networks, marketing, and various other business functions. Economies of scale represent a cost advantage that arises with increased output of a product. As production scales up, the cost per unit of the product decreases, primarily due to the spreading of fixed costs over a larger number of goods. This concept is pivotal in many industries, as it can lead to a competitive advantage for companies that are able to operate on a larger scale.

The learning effect can lead to a learning curve – which represents how average costs of production change over time. Case studies of the learning curve effect could involve its application in industries such as manufacturing, aviation, software development, and healthcare, each demonstrating different aspects of operational improvements over time. The service industry’s learning curve is a dynamic concept that encompasses various aspects of service delivery. By focusing on employee development, process optimization, and customer engagement, service providers can harness the power of the learning curve to achieve significant gains in efficiency and customer satisfaction. The key is to maintain a balance between standardization for efficiency and customization for individual customer needs. From a manufacturing perspective, economies of scale can be achieved through bulk purchasing of materials, which reduces the cost per unit of raw materials.

In the realm of production, the phenomenon where increased production leads to lower costs per unit is a pivotal aspect that merits meticulous examination. This effect, often quantified as a percentage improvement with each doubling of units produced, is not merely a reflection of economies of scale but also encapsulates the enhanced efficiency and proficiency workers gain through repetition. The concept of the learning curve is deeply rooted in the history of economic thought and industrial practice, tracing back to the early 20th century. It was first observed and documented by psychologists studying the process of learning. They noticed that as individuals repeated a task, their proficiency improved, and the time taken to complete the task decreased.

The developmentof experience curves is attributed to the work of Bruce Henderson of the BostonConsulting Group around 1960. An 80 percent learning curve means that the cumulative averagetime (and cost) will decrease by 20 percent each time output doubles. In otherwords, the new cumulative average for the doubled quantity will be 80% of theprevious cumulative average before output is doubled. The cumulative averagehours and cost as well as cumulative total hours and cost are provided below fordoubled quantities 1 through 8. If the learning rate is, say, 20% then we can conclude that every time, the quantity of output produced doubles the accumulated average time for all units produced to that point   will be 80% of its former level. E.g. if to produce first 10 units of X, an average of 100 man-hours each are required then to produce first 20 units of X (i.e. inclusive of the first 10 units of X) on an average 80 man-hours each will be required.