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Techniques, Isoquants, and Cost Curves
© 2010 Peter Berck
Definitions
• Output Q; specific amount Q*
• Inputs x= (x1…xn)
• If using inputs x results in output Q*, then x is a technique to make Q*.
– 1 brisket, 1 pan, 3 hours of oven services at 375, 1 large sheet foil, 4 coarsely sliced onions, salt, pepper, paprika are a technique for making pot roast. (Esther Lipow’s (z’’l) recipe.)
Efficient
• If x is less than or equal to y in every dimension and x and y both produce Q*, then y is not efficient.
– xi yi for every i
input 1
input 2 y
x
Isoquant
• Let Q* be some specific output like 4 units
• All efficient input combinations that produce Q* are the Q*th isoquant
Find points on same isoquant forCorn Yield in lbs.
Lbs N
Lbs P2O5 80 120 160 200
40 82.3 86.7 88.5 88.6
80 95.9 102.1 105.4 106.8
120 102.4 110.1 114.5 116.9
160 105.4 114.2 119.6 122.9
Rice Milling
• Why mill rice at all?
• What is wrong with white rice from a nutritional point of view?
Techniques for Milling Rice
Notes: Source P. Timmer Choice of Technique in Rice Milling in Java. Techniques
to produce Rp 10 Million in Value added . Investment in USD. Laborers is the number of
workers each and every year.
Technique Hand
Pound
Small
Mill
Investment 0 9,359
Laborers 45.83 13.95
Technique Large
Mill
Small
Bulk
Large
Bulk
Investment 29,675 44,335 77,835
Laborers 5.25 2.64 1.17
Milling
• Does a rice mill and hand pounding produce the same white rice product? Which would you rather buy?
• Why is this in value added rather than tons?
– VA = Revenue – Cost of materials
Isoquant for Rice Milling
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
0 10 20 30 40 50
Laborers
Invest
men
t C
ost
s
What Technique Minimizes Cost
• Need prices for labor and investment
• Price of investment is 1. Plant is assumed to last 50 years with no maintenance (urrg.)
• Price of 50 years worth of labor is calculated as the size of bank account (with 24% interest) that would pay a laborer $200 per year for 50 years. It is $833 per laborer
Interest Rates
• Is 24% per year a high interest rate for a developing country?
• Are there investment clubs in the US that charge their members 2.5% per month?
Outlay or Isocost Line
• All input combinations of K, investment, and L, laborers, that cost amount E, an unknown, are given by
• E = K + $833 L
• More generally:
• E = Pk K + PL L
About equi-cost or outlay lines
• E = Pk K + PL L
• K = E/Pk - L PL/PK
– So varying E (which is not known) gives a family of parallel equi-outlay lines
– The cost of every input bundle on the line is the vertical intercept times PK.
– When PK conveniently equals one, the vertical intercept is the cost of every bundle on the line
Which line?
• The least cost way of producing output Q* is found by finding the equi-cost line tangent to the Q*th isoquant.
• C(Q*) is the cost of any input bundle on that line
• The input bundle (or technique) at the tangency is the least cost way to produce Q*
Small Rice Mill Costs Least
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
0 10 20 30 40 50
Laborers
Invest
men
t C
ost
s
Hand
Small Mill
Story:
• Widows used to hand pound rice.
• Now SRM’s are used instead.
• How is this bad?
• How is this good?
Isoquant and Production Function
• The Q* isoquant: { x | x is an efficient technique and x produces Q*}
• Production function: Q = F(x). Output as function of (efficient) input bundles
– {x| F(x) = Q*, x efficient} is also isoquant
– Isoquant is level curve of production function
– see the physical model
Cost function is the
• Minimum amount of money necessary to buy the inputs that will produce output Q.
– Answer is amount of money as function of Q
• Isocost line, I: {x | I = p1x1 + p2x2}
– Straight line
• Intercept I/p2
• Slope - p1/p2
Pollution in an isoquant world
• Two goods
– Other stuff
– Clean Air Services
• negative of pollution
• air has 1 ppm of gunk –polluton
• air has 99 ppm of non-gunk – cleanth
Cost Min Technique
0
20
40
60
80
100
120
0 20 40 60
Air
Oth
er S
tu
ff Low
IsocostMed.
IsocostHigh
Isocost
Price of “Other Stuff” = 2
Equations for 3 lines. Cost of
Chosen bundle?
Isocost Lines:
0
20
40
60
80
100
120
0 20 40 60
Air
Oth
er S
tu
ff Low
IsocostMed.
IsocostHigh
Isocost
Price of “Other Stuff” = 2
Blue Isocost:
slope -2=- p1/p2; p1 = 4; I =
80*2=160; 160 =4 Air + 2 OS
Green Isocost: 200 = 4 Air + 2 OS
.Red Isocost: 120 = 4 Air + 2 OS
C(Q*) = 160
0
20
40
60
80
100
120
0 20 40 60
Air
Oth
er S
tu
ff Low
IsocostMed.
IsocostHigh
Isocost
Price of “Other Stuff” = 2
cost 200
cost 160
Chosen
(24,32)
C(Q1)=120, C(Q*)=160, C(Q2)=200
0
20
40
60
80
100
120
0 20 40 60
CAS
OS
Low
IsocostMed.
IsocostHigh
Isocost
C(Q)
• Plot Q1, Q2,Q3 against 120,160,200.
• That is your cost curve.
• You can choose any set of increasing Q’s given the information you have been given.
Pollution Control
Technology Standard
• Technology is a way to do something (see above)
• Technology Standard
– Use a specific technology
• catalytic converters on cars.
• scrubbers on coal fired power plants.
• One chooses a technology standard to reduce emissions
Effluent Standard
• Effluent (or emissions) Standard
– Can emit no more than X tons per (choose one)
• megawatt hour (output)
• per year (absolute!)
• per ton of coal burned (per input)
– Obviously get very different results depending on what you choose
Technology Based Effluent Standard(TBES)
– First find a technology that reduces emissions at a reasonable cost
– Find out how much emissions would go down
– Then set an emissions standard for that amount.
– Used in both Clean Air Act and Clean Water Act
TBES
0
50
100
150
0 20 40 60
Air
Oth
er S
tu
ff
Regulator knows
of technique to
use only 20 units
of Air and make
Q*. Inefficient
Technique
Price of “Other Stuff” = 2
The Regulation:
• When you make Q*, you may use no more than 20 units of clean air services. You may use the technique the regulatory engineers have discovered (20,100) or any other technique that uses no more than 20 units of air and has output Q*
Why this way?
• Regulator knows that it can be done
• Regulator has upper bound on cost
• Regulator is assured of cleaning up the air.
Response to TBES
0
20
40
60
80
100
0 20 40 60
Air
Oth
er S
tu
ff
(20,50)
Technique (20,50) costs 180 and is least
cost way to make Q* using 20 units of air
Technique (20,80), the basis for the regulation, costs
240 and makes Q*.
Back Door Economics
• Best Practicable Technology
– used for water pre 1977
– means known technology at reasonable cost
• Best Available Technology
– used for water post 1983
– means any technology; but in practice is limited by cost
• Intent: Cleaner water under BAT.
What to read
• Chapter 8 in BH. Example is agricultural pollution.
– Isoquant = equal output
– Isopleth = equal pollution
An exercise
• Let Q = k x, where x is an input and k is a positive number. Let w be the price of the input x.
• What is the least cost way of making Q?
• What is C(Q)?
Conditional Factor Demand
• How much of an input will be used as a function of output required and prices of inputs?
• X(Q,p)
• How could changing the price of clean air result in the same usage of clean air / unit output as the TBES regulations?
Our Assumption
• Firm’s need to dispose of waste gas, which they vent to the air. It is never free to vent the gas--it requires fans to push it out.
• Firm’s can dispose of less gas and make the same output by using more of another input. For instance, by buying capital in the form of an afterburner.
Air as a function of price
0
50
100
150
200
250
0 20 40 60
Air
Oth
er S
tu
ff
P1 = 4;
A=24
P1=16.7;
A= 16
Price of “Other Stuff” = 2
Conditional Factor Demand
0
5
10
15
20
0 10 20 30
Quantity of Clean Air Used
Pric
e of C
le
an
A
ir
In this chart the output is held constant at Q*.
Using Prices
0
20
40
60
80
100
0 20 40 60
Air
Oth
er S
tu
ff
(20,50)
Slope on High Price line is -100/15 = -p1 /2 so p = 13.3.
A price for air of 13.3
achieves the same level of
clean air as the TBES of 20
units of air.
Using Prices
0
20
40
60
80
100
0 20 40 60
Air
Oth
er S
tu
ff
(20,50)
Pollution charge of 13.3- 4 = 9.3 adds $465 to cost
Before pollution charge, it
already cost $4/unit to use
the air to dispose of waste
Summary
• Both a TBES and a pollution charge can produce the same level of use of clean air services and pollution.
• A TBES does not cost the firm, so C(Q; TBES) < C(Q; pollution charge) when the TBES and charge result in the same use of air
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