Experience Curve (Economics) - Explained
What is the Henderson's Law?
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What is the Experience Curve (Henderson's Law)?
The experience curve is also known as Henderson's law. An experience curve is an economic term which means that the more a firm produces of a particular good or service, the more it gains in efficiency. Thus, the cost of production decreases in proportion to the volume of products produced. Bruce D. Henderson and Boston Consulting Group (BCG) introduced experience curve in 1960s when they were analyzing the cost behavior of products.
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Experience Curve Formula
The formula for the experience curve is:
- C1 is the cost of the first unit of production
- Cn is the cost of the n-th unit of production
- n is the cumulative volume of production
- a is the elasticity of cost with regard to output
Reasons for the Effect
There are many reasons of experience curve. Following are the reasons:
- Labor efficiency- As the labor force works on particular goods and services, they become more skillful and efficiency. Also, they become less hesitant, make little mistakes, and experiment confidently. With the passage of time they learn new skills and have strong command of producing particular products. Labor efficiency covers administrative staff as well.
- Standardization, specialization, and methods improvements- When employees are assumed to work on specific task in which he/she specializes, they become more productive. Also, standardization of tools, techniques, processes, material, etc., increase the organizational efficiency. This allows the firm to achieve cost reductions and earn more profit.
- Technology-Driven Learning Information technology and new machines enable workers to use new methods of production.
- Product redesign - As the company specializes in a particular industry, it becomes easy for them to produce goods and services in bulk at a lower price. This enables them to achieve cost efficiency.
- Shared experience effects - When similar goods and services share common operation and functions, the efficiency achieved from one product may be applied to other product as well. And, hence, experience curve effects are reinforced.
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