Various capital and labor combinations to produce 5000 units of output abcde Units of capital (K)40201064 Units of labor (L)512203050.

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Presentation transcript:

Various capital and labor combinations to produce 5000 units of output abcde Units of capital (K) Units of labor (L)

a b c d e TPP = 5000 O

An isoquant map O I1I1 I2I2 I3I3 I4I4 I5I5 L K

MRTS ( marginal rate of technical substitution ) MRTS is the amount of one factor (e.g. K) that can be replaced by a one unit increase in the other factor (e.g. L), if output is to be held constant. Therefore, if 2 units of capital could be replaced by one unit of labor: MRTS = ∆ K = 2 = 2 ∆ L 1

Slope of an isoquant L K O 12 2 g 10 h 3 ∆ K = 2 ∆ L =1 MRTS = ∆ K = 2 ∆ L ∆ K.MPP K = ∆ L.MPP L rearranging ∆ K = MPP L ∆ L MPP K Also MRTS = ∆ K = MRTS ∆ L MRTS = MPP L MPP K

Returns to scale ConstantIncreasingDecreasing

Constant returns to scale a b c K L O R

Increasing returns to scale a b c K L O R

Decreasing returns to scale a b c K L O R

K L L6L6 L5L5 L4L4 L3L3 L2L2 L1L1 I1I1 I2I2 I3I3 I4I4 I5I5 I6I6 I7I7 O K Increase in output when K is Constant

K L L1L1 O K L2L2 L3L3 I1I1 I2I2 I3I3 When the isoquants are straight lines

Non diminishing returns to factor K L L1L1 O K L2L2 L3L3 I1I1 I2I2 I3I3 L4L4 I4I4

Assume 1. Factor prices are fixed i.e. P K and P L remain unchanged. 2. Firm’s budget is also fixed e.g. Rs. 300,000. Table Units of capital( Rs. 20,000 per unit) Units of labor ( Rs. 10,000 per unit)

30 15 Isocost line L K O Isocost line What will happen to the isocost if the prices of both L and K rise by the same percentage

30 15 Isocost line L K O 20 Isocost line What will happen to the isocost if the wage rate rises to Rs. 15,000?

The least cost combination of factors for producing a given level of output Output = 5,000 units TPP = 5000 r O K L s t 20 TC = Rs. 400,000

Highest output for a given cost of production L O K TPP 4 L TPP 3 TPP 2 TPP 1 TPP 5