unit 2.1 2016 students [compatibility mode].pdf

8/17/2019 Unit 2.1 2016 students [Compatibility Mode].pdf

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Outcomes• Define an isoquant.• Define and illustrate an isoquant.

• Explain and illustrate the charateristics of an isoquant.• Explain the difference between an isoquant an a indifference curve.• Define the marginal rate of technical substitution(MRTS)• Discuss the characteristics of the MRTS.

• Discuss and illustrate the variables that influence the shape of theisoquant and MRTS.• Define returns to scale.• Illustrate and explain the difference between increasing, decreasing

and constant returns to scale.

• Distinguish between the law of diminishing returns and decreasingreturns to scale.


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The Production Function• Production function: the relationship that

describes how inputs like capital and labour aretransformed into output.

• Mathematically,

Q = F (K , L)

K = CapitalL = Labour


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The Production Function• Long run: the shortest period of time required to alter

the amounts of all inputs used in a production process.

• Short run: the longest period of time during which atleast one of the inputs used in a production processcannot be varied.

• Variable input: an input that can be varied in the short

run.

• Fixed input: an input that cannot vary in the short run.


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Production In The Long Run• Isoquant: the set of all input combinations

that yield a given level of output.

• Marginal rate of technical substitution(MRTS): the rate at which one input canbe exchanged for another without altering

the total level of output.


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Characteristics of isoquants• Isoquant which lies further from the origin

is preferred – higher output level – Point D > Point C > Point A

• Downward slope and convex to the origin due to

decreasing MRTS


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Figure 7.11: Part of an Isoquant Map for the

Production Function Q = 2KL

Labour (L) 0


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Marginal Rate

of Technical Substitution (MRTS)

– MRTS – the rate at which one input is

sustituted or another, while the output level isheld constant.

• MRTS decreases with a movement along the

curve• To keep output constant – as more of the one input

sacrificied, more of the other input must be addedto compensate for the one unit reduction of the first

input (due to decreasing MP).

MPK K = MPL L

Therefore: MPL

/ MPK

= K/ L


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Figure 7.14: The Marginal Rate

of Technical Substitution

0


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Different isoquants• Diffferent shapes reflects different MRTS

• Fig. 7.15• Perfect input substitute

– MRTS = 1• Perfect compliments

• Inputs used in fixed combinations

• MRTS = 0 of ∞


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Figure 7.15: Isoquant Maps for Perfect

Substitutes and Perfect Complements


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Returns to scale – Large vs small plant = which one is the most

efficient? – Relationship between scale and efficiency =

returns to scale.

– Returns to scale : What will happen withoutput if all inputs are increased with the

same proportion?

– All inputs – a long term concept.


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Returns to scale (continue)• Increasing returns to scale

– Proportion in inputs lead to a higherproportional in output

• Eg.: double inputs→ more than double output

• Cause: possibility for specialization in larger firms

– Effect:

– smaller number of firms supply most of the

market

– Large plant an advantage.


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Returns to scale (continue)• Constant returns to scale

• Proportion in inputs result in exactly thesame proportional in output

– Double inputs = double output

– Effect :

– Large plant can be an advantage or adisadvantage.


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Returns to scale (continue)• Decreasing returns to scale

– Proportional

in inputs lead to a smaller

in output – Double inputs→ less than double output

– Cause:

– organization and communication problems – firmsbecome too big – Shortage of management / entrepreneurial sources

– Effect :

– Usually no large firms – plenty small firms supply themarket.

– Large plant a disadvantage.


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Figure 7.16: Returns to Scale Shown

on the Isoquant Map


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Important production concepts

• Economies of scale: over the long run, the averagecosts per product declines as the scale of production

increases.

• Returns to scale: what happens to output if all inputschange with x-percent.

• Diminishing returns : short term concept – if other inputsare fixed, the increase in output (marginal product)resulting from an increase in variable inputs, will

eventually decline.

• Economies of scope: Decline in average costs as aresult of the production of 2 or more different products.

unit 2.1 2016 students [compatibility mode].pdf

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