marginal rate of technical substitution: the rate at which one factor can be substituted for another...
TRANSCRIPT
Marginal Rate of Technical Substitution:Marginal Rate of Technical Substitution:
The rate at which one factor can be substituted for another factor while maintaining a constant level of output.
MRTS = Slope of the Isoquant.
L
K
L
KMRTS
AB
L
K
K
L
Q=10
0
K
QMPK
L
QMPL
KMPQ K LMPQ L
LMPKMP LK
K
L
MP
MP
L
K
K
L
MP
MP
L
KMRTS
The shape of the isoquant reflects the degree to which one input can be substituted for another in production. The smaller the curvature of an isoquant, the greater is the degree of substitutability of inputs in production.
The shape of the isoquant reflects the degree to which one input can be substituted for another in production. The smaller the curvature of an isoquant, the greater is the degree of substitutability of inputs in production.
L L
KK
Perfect SubstitutesPerfect Substitutes Perfect ComplimentsPerfect Compliments
Isocost Line:Isocost Line:
An Isocost line shows the various combinations of inputs that a firm can purchase or hire at a given cost.
C = wL + rK
Lr
w
r
CK
r
C
Lr
w
r
CK
L
K
0
A
B
C
D
0 L
10
20
30
K
r
WMRTS
Expansio
n Path
r
WMRTS
K
L
MP
MPMRTS
r
w
MP
MP
K
L
r
MP
w
MP KL
r
MP
w
MP KL
To minimize production costs or to maximize output for a given cost outlay, the extra output or marginal product per dollar spent on labor must be equal to the marginal product per dollar spent on capital.
Profit Maximization:Profit Maximization:
MRPL = MRCL = w
MRPK = MRCK = r
wMPMR L
rMPMR K
r
w
MP
MP
K
L r
MP
w
MP KL
0 3 6
3
6
Q=100
Q=200
L
K
0 3 6
3
6
Q=100
Q=300
L 0 3 6
3
6
Q=100
Q=150
L
Cost Analysis:Cost Analysis:
Explicit Costs:
The actual expenditure of a firm to hire, rent, or purchase the inputs it requires in production. For example, the wages to hire labor, the rental price of capital, equipment and buildings, and the purchase price of rawmaterials and semifinished products.
The actual expenditure of a firm to hire, rent, or purchase the inputs it requires in production. For example, the wages to hire labor, the rental price of capital, equipment and buildings, and the purchase price of rawmaterials and semifinished products.
Implicit Costs:Implicit Costs:
The opportunity cost of the inputs owned and used by the firm in its own production. Even though the firm does not incur any actual expenditure to use these inputs, they are not free in the sense that the firm could have sold or rented them out to other firms. The amount for which the firm could sell or rent out these inputs, constitutes the implicit cost of production.
The opportunity cost of the inputs owned and used by the firm in its own production. Even though the firm does not incur any actual expenditure to use these inputs, they are not free in the sense that the firm could have sold or rented them out to other firms. The amount for which the firm could sell or rent out these inputs, constitutes the implicit cost of production.
Short Run: The time period during which some of the firm’s inputs remain fixed.
Short Run: The time period during which some of the firm’s inputs remain fixed.
Long Run: The time period when all the inputs can be varied and only technology remains fixed
Long Run: The time period when all the inputs can be varied and only technology remains fixed
Very Long Run: Everything can change.Very Long Run: Everything can change.
Components of S.R Cost Function:Components of S.R Cost Function:
TC = TFC + TVCTC = TFC + TVC
Q
TFCAFC
Q
TVCAVC
AVCAFCq
TVCTFC
Q
TCATC
Q
TVC
Q
TCMC
O TFC TVC TC MC AFC AVC ATC0 50 0 50 ---- ---- ---- ----1 50 50 100 50 50 50 1002 50 78 128 28 25 39 643 50 98 148 20 16.7 32.7 49.34 50 112 162 14 12.5 28 40.55 50 130 180 18 10 26 366 50 150 200 20 8.3 25 33.37 50 175 225 25 7.1 25 32.18 50 204 254 29 6.3 25.5 31.89 50 242 292 38 5.6 26.9 32.4
10 50 300 350 58 5 30 3511 50 385 435 85 4.5 35 39.5
TC,
TVC,
TFC
TFC
Q
Q
Q1 Q2
ATCMC
AVC
AFC
0
0
Long-Run Total Cost:Long-Run Total Cost:
Total Cost
Q
$
0
Constant Returns to ScaleConstant Returns to Scale
2 3
Total Cost
Q
$
0
Decreasing Returns to Scale or Increasing CostsDecreasing Returns to Scale or Increasing Costs
Total Cost
Q
TC
0
Increasing returns to scale or decreasing costIncreasing returns to scale or decreasing cost
Increasing Returns
Decreasing Returns
Q
TC
0
Total C
ost
Elasticity of Cost with respect to Output:Elasticity of Cost with respect to Output:
ATC
MC
TC
Q
Q
TC
CTC
EC
(Q)Output in change Percentage
(TC)Cost Totalin change Percentage
If, EC < 1, increasing returns or decreasing cost.
If, EC = 1, Constant Returns
If, EC > 1, Decreasing returns or Increasing cost.
Short-run Vs. Long-run Average CostShort-run Vs. Long-run Average CostShort-run Vs. Long-run Average CostShort-run Vs. Long-run Average Cost
Q
$ per unit of Output
SRA
C A
SRA
C B SRA
CC
SRA
CD
Q1Q2 Q30
LRAC