isoquant to cost curves
TRANSCRIPT
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Isoquant to Cost Curves
© 1998 Peter Berck
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Review TechniqueTechnique to make Q*: bundle of
inputs that makes Q*Efficient technique to make Q*:
x is an efficient technique if there is no technique, y,that also makes Q* such that y has less of one input and not more of any input
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Isoquant and Production FunctionThe 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
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Bressler 1952 Exampley = 20+ 6.67 x2 + 10 x3 - .5 x3
x2
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Cost functionMinimum 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
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Problem AgainGiven that we want to produce on
isoquant Q*, which technique on Q* should we choose?
Answer: The technique on Q* that is on the lowest possible isocost line
The graph: Q* isoquant and many isocost lines.
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GraphTwo goods
Other stuff Clean Air Services
negative of pollutionair has 1 ppm of gunk –pollutonair has 99 ppm of non-gunk – cleanth
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Cost Min Technique
0
20
40
60
80
100
120
0 20 40 60
Air
Oth
er S
tuff Low
IsocostMed.IsocostHighIsocost
Price of “Other Stuff” = 2
Equations for 3 lines. Cost ofChosen bundle?
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Isocost Lines:
0
20
40
60
80
100
120
0 20 40 60
Air
Oth
er S
tuff Low
IsocostMed.IsocostHighIsocost
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
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C(Q*) = 160
0
20
40
60
80
100
120
0 20 40 60
Air
Oth
er S
tuff Low
IsocostMed.IsocostHighIsocost
Price of “Other Stuff” = 2
cost 200
cost 160
Chosen(24,32)
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C(Q1)=120, C(Q*)=160, C(Q2)=200
020406080
100120
0 20 40 60CAS
OS
LowIsocostMed.IsocostHighIsocost
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C(Q)Plot Q1, Q2,Q3 against 120,160,200.That is your cost curve.You can choose any set of increasing
Q’s give the information you have been given.
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Pollution Control
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Technology StandardTechnology is a way to do
something (see above)Technology Standard
Use a specific technologycatalytic converters on cars.scrubbers on coal fired power plants.
One chooses a technology standard to reduce emissions
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Effluent StandardEffluent (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
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TBESTechnology Based Effluent Standard
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
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TBES
0
50
100
150
0 20 40 60Air
Oth
er S
tuff
Regulator knowsof technique touse only 20 units of Air and makeQ*. InefficientTechnique
Price of “Other Stuff” = 2
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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*
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Why this way?Regulator knows that it can be doneRegulator has upper bound on costRegulator is assured of cleaning up
the air.
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Response to TBES
020406080
100
0 20 40 60Air
Oth
er S
tuff
(20,50)
Technique (20,50) costs 180 and is leastcost way to make Q* using 20 units of air
Technique (20,80), the basis for the regulation, costs240 and makes Q*.
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Back Door EconomicsBest 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.
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What to readChapter 8 in BH. Example is
agricultural pollution.If you are interested, get
Environmental Law and Policy and read it.
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An exerciseLet 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)?
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Conditional Factor DemandHow 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?
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Our AssumptionFirm’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.
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Another applicationIn India the ratio of the price of labor
to capital is much less than in the USThe USSR consistently priced capital
below its true value to the “evil empire.” Does this help explain the emphasis on heavy industry and big dams?
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Air as a function of price
050
100150200250
0 20 40 60Air
Oth
er S
tuff
P1 = 4; A=24
P1=16.7;A= 16
Price of “Other Stuff” = 2
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Conditional Factor Demand
0
5
10
15
20
0 10 20 30
Quantity of Clean Air Used
Pric
e of
Cle
an A
ir
In this chart the output is held constant at Q*.
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Using Prices
020406080
100
0 20 40 60Air
Oth
er S
tuff
(20,50)
Slope on High Price line is -100/15 = -p1 /2 so p = 13.3.
A price for air of 13.3achieves the same level ofclean air as the TBES of 20units of air.
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Using Prices
020406080
100
0 20 40 60Air
Oth
er S
tuff
(20,50)
Pollution charge of 13.3- 4 = 9.3 adds $465 to cost
Before pollution charge, italready cost $4/unit to usethe air to dispose of waste
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Summary So FarBoth 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
AC is lower with a Quota!
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Does MC increase?The case of the quota adjusted for
outputAssume quota increases from 20 to 28
units with additional output. Next slide is the Q and Q+1 isoquant.MC under price or quantity regulation
is the cost of the inputs to go from Q to Q+1
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What of MC?
020406080
100
0 20 40 60Air
Oth
er S
tuff
(20,50)
(28,60)
QQ+1
Additional Inputs = (28,60) - (20,50) = (8,10)
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MC is cost of added inputsMC under price regulation is:
additional inputs (8,10) at prices (13.3,20) MC is $306
MC under a quota: $2 unit * 10 units is $20 $ 0 unit * 8 units is $0 MC is $200
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Tax and Quota Same?MC is steeper under an output
increasing quotaAC is lower under (any) quotaLong run: Long Run Supply is where
P = AC With entry of new firms industry output
goes up Requires pollution quota for new firms
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Some RealityQuotas are often per unit of output
allows expansion of output more cheaply but pollution expands too
Another plan is a fixed quota across industries that is tradeable. expansion in one industry means
contraction in anotheror more efficient use of pollution quotapollution remains fixed
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Review: C(Q) and X(Q*,p)
0
50
100
150
0 20 40 60CAS
OS
Price of OS is 3